Question

2. If the Fed orders a contractionary monetary policy, describe what will happen to the following variables relative to what would have happened without the policy: (35 points)

a. The money supply

b. Interest rates

c. Investment

d. Consumption

e. Net Exports

f. The aggregate demand curve

g. Real GDP

Please give an answer for all of them!! Thank you.

Answer 1

Answer
a)
Monetary policy uses the money supply to stabilize the economy.
A contractionary monetary policy means to decrease the money supply, so the contractionary policy decreases the money supply.

b)
A decrease in the money supply shifts the money supply curve to the left which increases the interest rate in the economy.

c)
The increase in interest rate decreases investment spending as the opportunity cost of investment increases.

d)
The increase in interest rate decreases consumption spending as the opportunity cost of the consumption increases.

e)
The increase in interest rate decreases import which increases net export but it depends on the exchange rate as the increase in interest rate rises foreign investment in the economy which appreciates the exchange rate, so the import becomes cheap and that increases imports and decreases export, so the effect is undetermined

f)
the decrease in consumption, investment decreases AD and shifts AD to the left

g)
The decline in AD reduces real GDP and price level in the economy.