# What makes interest rate important when central bank

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Chapter 11 / Exercise 62
Finite Mathematics and Applied Calculus
Costenoble/Waner
Expert Verified
°What makes interest rate important? When Central Bank increases (de-
Example 1: Graphically show the e/ects of i) a contractionary monetarypolicy and ii) an expansionary ²scal policy on aggregate demand curve (do itseparately).Example 2:Assume that your country is going through a serious debtproblem (Greece!) and government just signed an IMF agreement to borrow.The release of the funds is contingent upon cutting the military spending by halfand laying some public workers o/. Starting with LR equilibrium and assumingall else is constant (and ignoring the secondary e/ects), answer the followingquestions:1. Show the e/ects of this policy on IS-LM diagram.2. How is this translated to AD-AS diagram? (As a movement along curves?A shift? No e/ect at all?)3. Assume now that Central Bank reacts to this by one of the followingpolicies. For each of them, analyze the short and long run of the economy.Use both IS-LM and AS-AD diagrams to analyze.3
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Chapter 11 / Exercise 62
Finite Mathematics and Applied Calculus
Costenoble/Waner
Expert Verified
(a) Keep money supply constant(b) Keep interest rate constant(c) Keep income constantNote that these policy reactions from Central Bank all happen in the shortrun.Example 3:Analyze the e/ects of oil-shock on economy using both IS-LMand AD-AS models.4
1.(a)EXERCISES1. If real money balances enter the IS-LM model both through the theory ofliquidity preference and the Pigou e/ect, then a rise in the price level willshift: