Consider an economy. This economy’s real GDP is constant. The government decides to buy out the...

Consider an economy. This economy’s real GDP is constant. The government decides to buy out the government bonds from the commercial banks. What macroeconomic variables will such policy affect? Explain why. Would this effect be different if there was more output produced in the same year? What concept explains this?

Expert Solution

Buying bonds from banks will increase money supply. Higher supply of money will decrease interest rate, which will boost investment demand, and the portion of consumption demand funded by borrowing. As a result, aggregate demand will increase. As the AD curve shifts rightward, real GDP will increase (causing an inflationary gap), price level will increase (raising inflation) and unemployment will decrease.

If more output was produced during the year, this would have increased real GDP (since real GDP measures value of current output at base year prices), so the inflationary effect of higher aggregate demand would have been the same.

Rahul Sunny answered 2 years ago

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