What happens to the output gap, the real interest rate, and net ...

[tiara099]

What happens to the output gap, the real interest rate, and net capital flows with the occurrence of each of the following events? Assume that exchange rates are flexible.
 
  a. The Federal Reserve increases the money supply.
  b. U.S. net exports decrease due to a decrease in incomes in Canada.
  c. Consumers decide to save more and spend less.
  d. Expected profits from newly-built factories in the United States decrease.

Question 2

If the inflation rate target is 2, the current inflation rate is 3, and the output gap is 2, then according to the Taylor rule, the nominal federal funds rate should be ________ percent.
 
  A) 4.5
  B) 7
  C) 6.5
  D) 5.5
  E) none of the above

[manuelcastillo]

Answer to Question 1

a. If the Federal Reserve increases the money supply, the MP curve shifts down, causing interest rates to fall. Output rises, and net capital outflows increase as the interest rate falls.
b. If U.S. net exports decrease due to a decrease in incomes in Canada, the IS curve shifts to the left. The NCF curve shifts to the left since net capital outflows decrease at every interest rate. Output falls, the interest rate remains unchanged, and net capital outflows decrease.
c. If consumers decide to save more and spend less, consumption falls and the IS curve shifts to the left. Output falls, the interest rate remains unchanged, and net capital flows do not change.
d. If expected profits from newly-built factories in the United States decrease, the IS curve shifts to the left due to the decrease in investment. Output falls, the interest rate remains unchanged, and net capital flows do not change.

Answer to Question 2

C