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Question

Assume that people and businesses have reasonable expectations. Explain how the events listed below will affect aggregate output and the price level. a. The Fed reduces the required reserve ratio unexpectedly. b. Congress passes a tax-cut bill that takes effect in a year and lasts ten years. c. The Fed announces a reduction in the money supply. d. OPEC abruptly reduces oil production by half. e. The government passes an unannounced emergency defence spending bill, authorising a $500 billion increase in funding immediately.

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In this problem, we are asked to determine how each event will affect the economy if firms and households have rational expectations.

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