During the 1980’s President Reagan pushed for significant tax cuts as a way to promote consumer spending. This extra money that consumers found they had also began to drive up prices causing the Federal Reserve to enact monetary policy to combat inflation.
a) Graphically show using the IS-LM model this era if the Fed is successful in controlling inflation by keeping the income level in the country constant.
b) What if instead of trying to keep income constant the Fed was worried about rising interest rates and thus wanted to keep the interest rate constant, show that effect using the IS-LM model.
c) Now assume that in an attempt to combat inflation, the Fed contracted the money supply too much and actually reduced the level of output in the country leading to a recession. Graphically show this result using the IS-LM model.