Briefly explain whether the following statement is true or false. In the AD-AS model, monetary policy...

Briefly explain whether the following statement is true or false.

In the AD-AS model, monetary policy cannot stabilize both the price level and the level of real GDP following a shock to aggregate supply.

Please answer elaborately with proper reasoning, graphs and equations. Also include a policy example.

Solutions

Expert Solution

In the AS-AD model, monetary policy cannot stablizes both the price level and the level of real GDP following a shock to aggregate supply.

The above statement is 'true' .
According to many theories of macroeconomics, a rise in the supply of money should decrease interest rates in the economy. An increase in the money supply means that more money is accessible for borrowing in the economy. This growth in supply–in accordance with the law of demand–tends to decrease the price for borrowing money. When it is easier to obtain money, rates of consumption and lending (and borrowing) both lean to go up.
Diagram:-1
In the long run, money is neutral: shifts in the money supply affect only the price level in the long run.An increase in AD due to an increase in the money supply shifts the AD curve up to the right. Equilibrium shifts from point A to B in the short run. Costs will eventually rise as well. So, the SRAS curve will shift up to the left. Long-run equilibrium is always on the LRAS curve at the economy's potential level of GDP. Changes in aggregate demand do not have a long lasting effect on GDP, only on the price level.
Diagram:-2

Rahul Sunny answered 1 year ago

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