Question

An unanticipated expansionary monetary policy has been implemented. Indicate the impact of this policy on each of the following four variables:

a. Inflation rate.

b. Real output and employment.

c. Real interest rate.

d. Nominal interest rate.

Answer 1

a. Inflation: By following expansionary monetary policy the money supply increases . Hence the demand of products and services will increase but supply remains same. Hence inflation will be there.This would decrease real interest rate in short term which would also increase demand .

b. Real output and employment. : Real output increases because when interest rates are low more will be the capital expenditure and higher will be the production. Employment will increase as companies would take up more project and increases capital expenditure to take advantage of lower interest rate due to expansionary policy.

c. Real interest rate decreases because in expansionary policy the fed reduces the policy rate or discount rate. This reduces the real interest in the economy.

d. Nominal interest rate might decrease immediately as real interest rate has decreases nut in the long run might increase due to inflation which is associated with rate cuts.