Question

Macroeconomic

ness cycle. 3. Fed Raises Rates As Job Gains, Firming Inflation Stoke Confidence O.S. Federal Reserve raised interest rates on nesday. The rate rise was the second in three Wed months. This second rise comes in an economy that is growing faster and creating jobs at a more rapid pace. These gains are accompanied by a ris- ing inflation rate. Source: Reuters, March 15, 2017 a. Describe the process by which the Fed's action reported in the news clip flows through the economy b. Draw a graph to illustrate the state of the economy that prompted the Fed to take the action described in the news clip c. Draw a graph to illustrate the Fed's action and its effect.

Answer 1

With increasing output and increasing inflation, we can say that the Aggregate Demand curve is shifting rightwards.
Now the corresponding IS-LM framework for this indicates that the IS curve has also shifted outward leading to a rise in interest rates becoming necessary.

Hence, the Fed increases the rate to r2, in order to stabilise the output at Y2, which is the equilibrium point at r=r2 and P=p2.

Therefore, the economy moves outward to Y2' at r1 and the fed in response to that increases the rates to r2, bringing the economy to the new equilibrium.
On the AD-AS curve, this results in increase in price level to P2.

Let me know if any queries.

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