Suppose an economy that starts in general equilibrium is thrown into a recession via a leftward...

Suppose an economy that starts in general equilibrium is thrown into a recession via a leftward shift in the IS curve. What type of monetary policy (expansionary or contractionary) could be beneficial in helping this economy return to general equilibrium? Why is such a policy beneficial? Are there consequences, risks or difficulties associated with implementing this policy? Discuss.

Solutions

Expert Solution

If an economy is thrown into a recessiond ue to leftward shift in IS curve. Fed should adopt expansionary monetary policy such that they raise money supply in the economy. Due to rise in money supply, LM curve will shift to its right causing rate of interest to fall. A reduction in rate of interest will raise investment in the economy.

Rise in money supply will raise circulation of money in the economy which will end up people holding more money in their pockets and raising their willingness to pay for goods. As willingness to pay for good rises, aggregate demand curve shifts to its right from demand to new demand curbing recessionary gap in the economy and shifting output level from Y0 to Y1.

Consequence of expansionary monetary policy is that is results in higher inflation rate in the economy.

Risk of expansionary monetary policy is the time lag between policy is implemented and results it shows in the economy. If there is case that aggregate demand rises automatically to reach its long run equilibrium and effect of monetary policy hits economy after that. It will results in higher inflation than expected.

Rahul Sunny answered 1 year ago

Next > < Previous

Related Solutions

If general equilibrium prices hold in every market in an economy, then, compared to the equilibrium...

If general equilibrium prices hold in every market in an economy, then, compared to the equilibrium allocation: Group of answer choices If some resources were moved from the production of good x to the production of good y, then the amount produced of each good must go down If some resources were moved from production of good x to production of good y, at least some consumers would have to give up more x than they are willing to trade...

Suppose that the economy is in a recession and assume that the IS curve is relatively...

Suppose that the economy is in a recession and assume that the IS curve is relatively steep while the LM curve is relatively flat. Without complications from other matters, which macro policy would be more effective in the very short run to lift the economy out of recession, fiscal or monetary? Illustrate your answer in a diagram.

1. Sometimes when the U. S. economy starts pulling out of a recession, the unemployment rate...

1. Sometimes when the U. S. economy starts pulling out of a recession, the unemployment rate actually rises for a time rather than immediately falling. This is commonly referred to as a "jobless recovery". There are 2 reasons for this strange phenomenon occurring. What are the 2 reasons? Explain. (Hint: Refer to the Extra PPT on Unemployment and Chapter 6 of the course text! You could also do an Internet search for "What is a jobless recovery?"!) 2. There are...

Sometimes when the U. S. economy starts pulling out of a recession, the unemployment rate actually...

Sometimes when the U. S. economy starts pulling out of a recession, the unemployment rate actually rises for a time rather than immediately falling. This is commonly referred to as a "jobless recovery". There are 2 reasons for this strange phenomenon occurring. What are the 2 reasons? Explain. (Hint: Refer to the Extra PPT on Unemployment and Chapter 6 of the course text! You could also do an Internet search for "What is a jobless recovery?"!) Additional questions to answer...

Suppose the economy is in long-run equilibrium.

Scenario 1 - Pessimism Suppose the economy is in long-run equilibrium. Then because of corporate scandal, international tensions, and loss of confidence in policymakers, people become pessimistic regarding the future and retain that level of pessimism for some time. Scenario 1 - Pessimism. Which curve shifts and in which direction? aggregate demand shifts right aggregate demand shifts left aggregate supply shifts right. aggregate supply shifts left.

Suppose the economy is in a recession. Which of the following is a valid argument for...

Suppose the economy is in a recession. Which of the following is a valid argument for using expansionary fiscal policy, instead of monetary policy? Select one: a. Fiscal policy is more effective than monetary policy in a deep recession b. Fiscal policy is slower than monetary policy c. Fiscal policymakers are subject to more political influence, so some of their spending tends to be wasteful. d. Government spending could lead to lower growth through the crowding-out effect

Question 2: Suppose there is a recession in the economy that is caused by a sudden...

Question 2: Suppose there is a recession in the economy that is caused by a sudden change in aggregate demand. a) Show the recession on a graph. What will happen to the price level, output and unemployment? b) Assuming no government intervention, what will happen in the long-run? c) Now suppose the government decides to intervene. What can be done? Is there a trade-off decision in this case? If there is, explain. d) Let’s assume that the recession in the...

Assume that the economy starts at the 'natural rate of output'. Now suppose there is a...

Assume that the economy starts at the 'natural rate of output'. Now suppose there is a decline in net exports due to the global economic downturn caused by COVID-19. Using the AD-AS diagram to show the effects in the short run and the medium run on the output, employment. and the price level. show how expansionary fiscal policy may influence these equilibrium positions.

Equilibrium in the loanable funds and goods markets: Suppose that the economy begins in equilibrium in...

Equilibrium in the loanable funds and goods markets: Suppose that the economy begins in equilibrium in the loanable funds and goods market. Then, the government decides to reduce its purchases without changing taxes. According to the Classical model: a) How do the supply and demand for loanable funds in the loanable funds market shift? Draw a diagram to show what happens to interest rates and investment in the new equilibrium. b) How do the supply and demand for goods in...

Suppose the Fed would like to stimulate the economy that is In a state of recession....

Suppose the Fed would like to stimulate the economy that is In a state of recession. Discuss what are the tools that the Fed would use to stimulate the economy and what will be the impact on the different variables such as the GDP, the Investment, Consumption , level of price ect .Show your work using graphical analysis.

Subjects