e Fed is considering two alternative monetary policies: ·Holding the money supply constant ·Adjusting the money...

e Fed is considering two alternative monetary policies:

·Holding the money supply constant

·Adjusting the money supply to hold the interest rate constant

In the IS-LM model, which policy will better stabilize output if

a) All shocks to the economy arise from exogenous exchanges in the demand for goods and services?

b) All shocks to the economy arise from exogenous exchanges in the demand for money?

Expert Solution

a ) If all shocks to the economy arise from exogenous exchanges in the demand for goods and services, then adjusting the money supply to hold the interest rate constant will be a better policy to stabilize thye output because if interesr rate get flactuating , there will be a change in investments of the country and net exports of the country , which are usually components which can flactuate the good and services and finally lead to the shocks in the country and country would be in derilict position . So to have a good demeanor , adjusting the money supply to hold the interest rate constant will be a better policy .

b ) If all shocks to the economy arise from exogenous exchanges in the demand for money , then Holding the money supply constant will be a good policy . Suppose increase or decrease in money supply cause by central banks lead to cumbersome problem for the country and put the county into a limping situation , then in such situation it's better for the country to hold it's money constant and move towards the fiscal policy to stay away from the dwelling results . So in such case holding money supply will be a better policy to be implemented

Rahul Sunny answered 2 years ago

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