1. During the last FOMC meeting on March 15 of this year, the FED decided to rai
ID: 1125313 • Letter: 1
Question
1. During the last FOMC meeting on March 15 of this year, the FED decided to raise the target range for the federal funds rate to 3/4 to 1 percent.
a. Assuming the raise in the federal funds rate will move real interest rates in the same direction, what impact would it have on aggregate output? (answer this question with the help of the IS curve)
b. The Trump administration has signaled that it may scrap several free trade agreements that the US has with different nations. Ignoring the impact on imports from these countries, if discarding these agreements reduces our exports, how would this affect the IS curve? Why?
Explanation / Answer
1). A rise in real interest rates will necessarily attract more foreign investment into the economy since the investors would expect a higher rate of return on their investment. Thus, the income levels will rise as a result of increased investment, thereby shifting the IS curve to the right. An increase in investment also increases the output level in the economy.
2). The IS curve will shift down to the left because according to the IS curve equation, Y = C + I + G + NX, and a reduction in exports will reduce the level of output and thus the level of income in the economy.
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