Suppose that the Fed sets the interest rate and adjusts the money supply accordingly (i.e., horizontal LM curve) and the economy is in recession.
(a) In this part, suppose also that private business investment spending depends only on sales expectations. What kind of policy mix would be able to increase output? Why? Explain. [Hint: Begin with showing the implications of assumptions first.]
(b) In this part, suppose also that private business investment spending depends on both sales expectations and the rate of interest. How would your answer in part (a) change? What if the interest rate is already equal to zero (i.e., the zero lower bound). What kind of policy mix would be able to increase output? Why? Explain.