Question

1. If a negative real shock occurred in the RBC model, and the central bank increases the money supply, what is the outcome? Will it have any effect on growth in the short run or long run?

Answer 1

If there is a negative real shock under RBC model, it would be a productivity shock that would shift the short run and long run aggregate supply curves leftward. This would raise the price level and reduce the level of output in the economy in the short run. However, markets makes the necessary adjustments quickly so that they would always return to the full employment equilibrium if any disturbance occurs. Here money is assumed neutral in raising the output level or having any real effect. If central bank raises money supply, it will only result in raising the price level, leaving output unaffected. Due to this reason, monetary policy will have no real effect in short or long run.