Assume that the economy falls into recession. (i.e., output falls below full employment output) and the...

Assume that the economy falls into recession. (i.e., output falls below full employment output) and the Fed describes by buying bonds.

Briefly describe the process by which the money supply is affected?

What does this do to the Interest rate?

Briefly explain the chain of causality of how monetary policy might help affect help move the economy back toward full employment output (That is, how can monetary policy affect AD in the short-run?)

Discuss the factors or circumstances that may make this policy less effective or even ineffective. Think broadly about this question.

Solutions

Expert Solution

Buying bonds by FED is an expansionary monetary policy. FED buys bonds and supply money in the economy. So money supply will be increased.

LM curve represents money market. So LM curve shifts to the right. As a result interest rate will fall.

At this low-interest rate, people tend to consume more instead of savings. So aggregate demand will be increased. In other words interest rate is the opportunity cost of investment. At the low-interest rate, investment becomes cheaper so people invest more, as a result, aggregate demand will be increased.

In IS-LM diagram IS curve represents goods market and LM curve represents money market. If IS cure is vertical that is perfect inelastic then the expansionary monetary policy will be ineffective. This policy just lowers the interest rate but fail to increase the aggregate demand. It fails to increase the employment level.

Rahul Sunny answered 1 year ago

Next > < Previous

Related Solutions

Draw an economy operating (SRAS=AD) below the full employment level of output. if the above economy...

Draw an economy operating (SRAS=AD) below the full employment level of output. if the above economy is left alone from government intervention, describe the Long Run adjustment. Long run adjustment: please specify the effects of this adjustment on: Nominal wage: output: Prices: Draw an economy operating (SRAS=AD) beyond the full employment level of output. if the above economy is left alone from government intervention, describe the Long Run adjustment. Long run adjustment: please specify the effects of this adjustment on:...

Assume the economy is at full employment as of January 2018 and the government passes a...

Assume the economy is at full employment as of January 2018 and the government passes a tax bill that reduces taxes by $100B.The tax, however, does not change government spending What effect is this likely to have on output and prices levels? What effect will this have on interest rates and investment? What is the likely response by the Federal Reserve? Suppose that the economy was below full employment, how would that change your answer?

Question 2 ) Begin with the economy at full employment. Now assume that there is a...

Question 2 ) Begin with the economy at full employment. Now assume that there is a decrease in Government purchases of goods and services. Analyze verbally the differing effects of this decrease in G in a i) Classical model and in a ii) fixed nominal wage Keynesian Model. Analyze what will be the effects on labor supply, labor demand, the level of unemployment, the level of prices, and the level of output? Show the effect in the labor market, the...

Question- Begin with the economy at full employment. Now assume that there is a decrease in...

Question- Begin with the economy at full employment. Now assume that there is a decrease in Government purchases of goods and services. Analyze verbally the differing effects of this decrease in G in a i) Classical model and in a ii) fixed nominal wage Keynesian Model. Analyze what will be the effects on labor supply, labor demand, the level of unemployment, the level of prices, and the level of output? Show the effect in the labor market, the IS-LM model...

Graph an economy where your actual output is above full employment output. Use the AD/SRAS and...

Graph an economy where your actual output is above full employment output. Use the AD/SRAS and LRAS model. Label all axis and lines accurately. a. Identify your potential or full employment output, Yf or Qf. b. Identify the actual output and price level. c. Identify the phase of the business cycle, the economy is operating within and explain how you know. d. Actual output= $750 Million Potential output =$ 600 Million MPC= .5 i. Calculate MPS. (write the formula and...

The Spartan economy has the following full employment output and expenditures. Y = 2100 Cd =...

The Spartan economy has the following full employment output and expenditures. Y = 2100 Cd = 100 + .75 (Y – T) – 2000 r T = 500 G = 400 Id = 600 – 3000 r Find the equilibrium real interest rate? What is the equilibrium desired national saving amount? i. How much is desired private saving? ii. How much is government saving? What is the equilibrium desired investment? What is the desired consumption? Draw the graph of the...

An economy has full-employment output of 1500. Suppose desired consumption and desired investment are ? ?...

An economy has full-employment output of 1500. Suppose desired consumption and desired investment are ? ? = 125 + 0.75(? − ?) − 400? ? ? = 200 − 100? G is the level of government purchases, and T=100 1. Goods market and the IS curve section. a) Derive desired saving with respect to Y and r if the government spending, G, is 150. b) Find the goods market clearing real interest rate if the full-employment output is 1500 and...

An economy has full-employment output of 1500. Suppose desired consumption and desired investment are ?? =...

An economy has full-employment output of 1500. Suppose desired consumption and desired investment are ?? = 125 + 0.75(? − ?) − 400? ?? = 200 − 100? G is the level of government purchases, and T=100 Money demand is ?? ? = 0.8? − 2000(? + ??) where the expected rate of inflation, ??, is 0.05. The nominal supply of money M = 2000. 2. Asset market equilibrium and the LM curve. i) Derive the LM curve when the...

The recession has meant that the actual output of the Australian economy is below the potential...

The recession has meant that the actual output of the Australian economy is below the potential output. The government has already introduced policy measures as you have identified above to boost aggregate demand (AD) and cover the output gap. However, from lecture 7 (Chapter 15) we can conclude that the road to economic recovery in Australia and mitigating the current output gap also requires policies to shift the short-run aggregate supply (SRAS) to the right. Discuss two of the distinct...

Assume that the United States economy is currently operating at the full employment level of real...

Assume that the United States economy is currently operating at the full employment level of real gross domestic product with a balanced budget. 1. Draw a correctly labeled graph of aggregate demand, short-run aggregate supply, and long-run aggregate supply, and show each of the following in the United States. a Current output and price level, labeled as Y1 and PL1, respectively b. Full-employment output, labeled as Y1

Subjects