Problem
Some economists believe that the income gains from a cut in lump-sum taxes will be completely wiped out (eliminated) by the Fed to prevent an increase in output prices in the long run.
I. Do these economists believe that the Fed will increase or decrease the policy rate?
Increase.
II. Do these economists believe that the U.S. economy - before the cut in taxes - is at full employment or below full employment?
Given that it argued that monetary policy to prevent increase in prices will completely eliminate the income gains, it is assumed that the economy starts from full-employment.
III. Illustrate the reasoning on these economists on an IS-LM-FE graph, indicating - with letter (i) the initial equilibrium - with letter (ii) the equilibrium after the cut in lump-sum taxes and - with letter (iii) the equilibrium that the Fed wants to attain.