Rule Based Monetary Policy and Debts and Deficits

1) Rule Based Monetary Policy: Below draw an AD/AS graph and a money market graph side-by-side. For the money market, use an upward sloping money supply curve and assume that the equilibrium interest rate in the money market is 5%. Also, assume that actual GDP is at full employment and that the equilibrium price level in the AD/AS graph is 100. Now shift AD to the right based on an increase in animal spirits. Show how the money market graph will adjust to a new equilibrium. Then explain and show what happens if the Fed acts to keep the equilibrium quantity of money constant. Is this rule based policy pro-cyclical or countercyclical? (explain)

2) Debts and Deficits: Compare the traditional view versus the view of Ricardian equivalence of the effects of a debt-financed tax cut on:

i) Current Consumption

ii) Current National Savings

iii) Current Interest rates