Explain how the economy adjusts back towards

Reference no: EM133504409

Question: Corporate bond interest rates are a good measure of the interest rate facing firms planning investments.

Before the financial crisis, this rate was about 2% higher than the fed funds rate. At the peak of the crisis in October 2008, the Baa rated bond rate was almost 9% higher than the fed funds rate.

a) Suppose the economy begins in steady state, and there is a shock to the interest spread ??¯. Use the IS-MP and AS/AD diagrams to graph and explain how the economy reacts if the Fed follows the simple monetary rule and does not change its inflation target.
b) Continuing from part a), use the AS/AD graph to explain how the economy adjusts back towards the steady state when the shock to ??¯ lasts for one quarter. How long does the recession last?

Reference no: EM133504409

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