Question

Trace the impact of an expansionary monetary policy on each one of the following: a) bond prices, b) interest rates, c) investment, d)the exchange rate, e) net exports, f) real GDP, and g) the price level. To the Tutor: Please be clear and explanatory as much possible on each of the answers. Will be appreciated. Thank you.

Answer 1

A.

Expansionary monetary policy will cause an increase in money supply and the interest rate will come down. Here, the bond prices are inversely proportional to the interest rate. So, decrease in interest rate will lead to increase in bond prices.

B.

Increase in money supply takes place with the expansionary monetary policy and more funds will be available for the disbursement. It will decrease the interest rate in the economy.

C.

Investment level will increase due to the expansionary monetary policy. It is the key objective of the expansionary monetary policy. It makes the interest rate to be at the lower level. It encourages the firms to make spending and investment increases.

D.

Due to expansionary monetary policy, money supply will increase and purchasing power of money will come down. As a result, the exchange rate will decrease for the domestic currency.

E.

Net export will increase because of the lower purchasing power of the currency. A weakening currency will bring pricing advantage in the international market and product will be cheaper. So, net export will increase.

F.

Real GDP will increase as aggregate demand increase with expansionary monetary policy. To cater the increase in aggregate demand, the increase in aggregate supply will take place. As a result, real GDP increases.

G.

Price level will rise, because the increased supply level, will increase the demand of input factors of the production. As a result, the demand pull inflation will take place and it will cause the cost of production to rise. So, price will rise.