Inflation in US Economy

. SHORT RUN CLOSED ECONOMY ANALYSIS Over the past two years the U.S. economy has experienced a significant and sustained decline in oil prices. In the past six months, the housing market, both new and resale, has experienced a significant increase in home prices across many areas of the U.S. Assume the U.S. was operating at LR equilibrium output prior to these two events.

A. Using an IS-LM diagram and an AD-AS diagram, show the effects of the rise in home prices on the US economy in the Short Run. Provide a brief explanation for how the U.S. economy would automatically adjust in the face of this shock without any policy intervention.

B. Using an IS-LM diagram and an AD-AS diagram, show a US monetary policy aimed at maintaining the inflation rate (i.e. keep the Price Level fixed) in the face of rising home prices. Specify the policy, how it will be implemented, what its effects will be in the SR and the LR, and the pros and cons of the policy.

C. Using an IS-LM diagram and an AD-AS diagram, show the effects of the falling oil prices plus the significant increase in home prices on the U.S. economy. What new effects, both beneficial and adverse, might the monetary policy of Part B. have on the U.S. economy? Why?

D. Provide a brief discussion of the benefits and risks of active monetary policy in the situation.

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