Macroeconomics 5th Edition by Olivier Blanchard

Exercise 3

Active monetary policy
a. Consider an economy with output below the natural level of output. How could the central bank use monetary policy to return the economy to its natural level of output Illustrate your answer in an IS-LM diagram.
b. Again suppose that output is below the natural level. This time, however, assume that the central bank does not change monetary policy. Under normal circumstances, how does the economy return to its natural level of out-put Illustrate your answer in an IS-LM diagram.
c. Considering your answer to part (b), if the central bank does nothing, what is likely to happen to expected inflation How does this change in expected Inflation affect the IS-LM diagram Does output move closer to the natural level
d. Consider the following policy advice: "Because the economy always returns to the natural level of output on its own, the Fed does not need to concern itself with recessions." Do your answers to parts (a) through (c) support this advice