(Solved): The graph on the right shows an IS-LM graph for an economy. Point A on the graph represents the eco ...

The graph on the right shows an IS-LM graph for an economy. Point A on the graph represents the economy at potential output, \( Y_{n} \), with the natural rate of interest, \( r_{n} \), and stable inflation. Assume the country is running a deficit at point A. If the govemment decides to raise taxes in order to reduce the deficit, what impact would this have in the short run? What action might the central bank take in the medium run? 1.) Using the 3-point curved line drawing tool, draw a new IS curve that reflects the govemment's efforts to reduce the deficit. Label your curve ' \( 1 \mathrm{~S}_{2} \) ". 2.) Using the point drawing fool, show the short-run equilibrium that results from having raised taxes. Label your point " \( \mathrm{A}_{2} \) ". 3.) Using the line drawing tool, draw a new LM curve that reflects the central bank's reaction to adjust the economy back to a medium-run equilibrium. Label your curve " \( \mathrm{LM}_{2} \). 4.) Using the point drawing tool, show the medium-run equilibrium that results from the efforts of the central bank. Label your point ' \( \mathrm{A}_{3} \) '. Carefully follow the instructions above and only draw the required objects. In this example, short-run fiscal consolidation leads to The central bank will react by the policy rate, and in the medium-run equilibrium, the economy is A. an expansion; raising; below potential output but the natural policy rate is back to its original level. B. a recession; lowering; back to potential output and back to the original natural policy rate. C. an expansion; raising; back to potential output but the natural policy rate is lower. D. a recession; lowering: back to potential output but the natural policy rate is lower. Real interest rate, \( r \)