Suppose the monetary authority desires to restore the output to the long run equilibrium level. Should...

Suppose the monetary authority desires to restore the output to the long run

equilibrium level. Should the monetary authority raise or lower the target interest

rate? Describe the

open market operation that would be needed to move the

interest rate to the new target.

Expert Solution

If output is less than long-run equilibrium (potential) output, there is a recessionary gap, which can be closed by decreasing the interest rate, by expansionary monetary policy using open market purchase of government securities that increases money supply. A fall in interest rate will increase investment demand and the portion of consumption demand funded by borrowing. Higher consumption and investment together increases aggregate demand, restoring output to its potential output level.

On the other hand, if output is higher than long-run equilibrium (potential) output, there is an inflationary gap, which can be closed by increasing the interest rate, by contractionary monetary policy using open market sale of government securities that decreases money supply. A rise in interest rate will decrease investment demand and the portion of consumption demand funded by borrowing. Lower consumption and investment together decreases aggregate demand, restoring output to its potential output level.

Rahul Sunny answered 2 years ago

Suppose the economy is initially in long-run equilibrium and the Fed adopts a looser monetary policy...

Suppose the economy is initially in long-run equilibrium and the Fed adopts a looser monetary policy and raises its long-run target for the inflation rate. a. Explain how this change in monetary policy will affect the AD curve. b. Use your result for part a along with an AD-AS diagram to illustrate and explain what will happen to output and inflation in both the short run and the long run.

Suppose the economy is initially in long-run equilibrium and the Reserve Bank adopts a looser monetary...

Suppose the economy is initially in long-run equilibrium and the Reserve Bank adopts a looser monetary policy and raises its long-run target for the inflation rate. a) Explain how this change in monetary policy will affect the aggregate demand (AD) curve. b) Use your result in part (a) along with an aggregate demand-aggregate supply (AD-AS) diagram to illustrate and explain what will happen to output and inflation in both the short-run and the long-run.

Using the AD-AS diagram, draw an economy in long run equilibrium. Indicate output and price level...

Using the AD-AS diagram, draw an economy in long run equilibrium. Indicate output and price level as Y1 and P1. Suppose a pandemic is affecting the economy and the Federal government invests heavily in diagnostic and anti-body testing, increasing government purchases by 10 billion. Indicate the effect on the economy using your diagram. Remember, decide which curve shifts and which direction. Indicate the new equilibrium with Y2 and P2. In words, what happens to the economy given the increase in...

An economy in its long-run equilibrium (i.e., output is at its natural level). Draw a graph...

An economy in its long-run equilibrium (i.e., output is at its natural level). Draw a graph of the AS curve in the short run and the AD curve and, in the graph, denote by A the pair ( Y,P) where the economy finds itself. The economy is now hit by a shock: the power of unions becomes temporarily very high so the cost of hiring workers increases substantially. (a) Is this a supply shock or a demand shock? Explain. (b)...

Suppose the economy is in long-run equilibrium.

Scenario 1 - Pessimism Suppose the economy is in long-run equilibrium. Then because of corporate scandal, international tensions, and loss of confidence in policymakers, people become pessimistic regarding the future and retain that level of pessimism for some time. Scenario 1 - Pessimism. Which curve shifts and in which direction? aggregate demand shifts right aggregate demand shifts left aggregate supply shifts right. aggregate supply shifts left.

Suppose the US economy is currently in long-run equilibrium at potential output. A tax overhaul lowers...

Suppose the US economy is currently in long-run equilibrium at potential output. A tax overhaul lowers corporate income taxes and adds $1.4 trillion to the national debt. Using economic reasoning and models as evidence, evaluate and discuss how this event will likely impact output, employment, interest rates and the price level in the A) short run and B) long run. Be sure to address any assumptions you make as well as the perspective you take.

Suppose the output or goods market is in equilibrium and the level of taxes in that...

Suppose the output or goods market is in equilibrium and the level of taxes in that country is increased. How does this affect the output market? Explain your answer through the sequence of change(s) on any variable(s) involved.

Consider the Canadian economy that is in long run equilibrium with output equal to Y*. The...

Consider the Canadian economy that is in long run equilibrium with output equal to Y*. The United States economy goes into a major slowdown causing a significant decrease in goods and services shipped into the United States from Canada. For the Canada, answer the following questions: A) What kind of shock occurred- aggregate demand or aggregate supply? Explain your answer. B) Explain the how fiscal policies by government of Canada can be used to drive the economy back towards Y*...

Suppose that the economy is at long-run equilibrium. If there is a sharp decline in the...

Suppose that the economy is at long-run equilibrium. If there is a sharp decline in the stock market combined with a significant increase in immigration of skilled workers, then in the short run a. real GDP will rise and the price level might rise, fall, or stay the same. b. real GDP will fall and the price level might rise, fall, or stay the same. c. the price level will rise, and real GDP might rise, fall, or stay the...

What is the long-run effect of the increased taxation on output and the price level?

Question