Explanation for IS LM Analysis with Taylor's rule.
The U.S. economy has suffered a severe economic slump.
a. Using ISLM analysis, describe why conventional monetary policy (as represented by the Taylor rule) is not able to work in this current economic climate.
i = i* +1.5(Πt-Π*) + .5*(Yt-Y*)
Where: i = nominal interest rate
i*= target nominal interest rate
Πt = rate of inflation
Π* = target rate of inflation
Yt = actual real GDP
Y* = Potential GDP
b. Suppose there was deflation. Using ISLM analysis, describe what effect it would have on the economy given the current circumstances?
c. Using ISLM analysis, elucidate what effect, if any, fiscal policy would have on the economy given the current economic conditions.
d. Given the circumstances, describe what the Fed is doing to stabilize the economy.