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Assume that before the changes, the economy was at the natural level of output and the central bank uses an

interest rate rule with a price level target.

(a) Show the effects of a reduction in consumer confidence on the position of the AD/AS and IS/LM curves in the short and medium run. Label your diagrams clearly. (10 marks)

(b) What happens to output, the interest rate and the price level in the medium run? What happens to consumption and investment in the medium run? Explain. (5 marks)

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