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There are two economies, Essos and Westoros. In Essos, most aggregate economic shocks happen in the...

  1. There are two economies, Essos and Westoros. In Essos, most aggregate economic shocks happen in the market for goods and services. In Westoros, money demand fluctuates a lot but the demand for goods and services is very stable. In each economy, the central bank is contemplating two alternative monetary policies:
    • Policy 1: pick a target interest rate, and try to hold it constant by varying the money supply.
    • Policy 2: pick a target amount of money supply, and try to hold it constant by letting the interest rate adjust freely.

The central banks' goal is to "stabilize" the economy, that is, to make GDP fluctuate as little as possible. Which of the two policies should Essos and Westoros each adopt? Why? (Hint: you will need to use the Liquidity Preference model AND the IS-LM model)

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Rahul Sunny answered 1 year ago
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