Draw an AD/AS graph and a money market graph side-by-side. For the money market, use an upward sloping money supply curve and assume that the equilibrium interest rate in the money market is 5%.
Also, assume that actual GDP is at full employment and that the equilibrium price level in the AD/AS graph is 100.
(i) Now shift AD to the right based on an increase in animal spirits. Show how the money market graph will adjust to a new equilibrium. Then explain and show what happens if the Fed acts to keep the equilibrium quantity of money constant.
(ii) Is this rule based policy pro-cyclical or countercyclical? (explain)