Question

8 (12-13 pts) Assume the economy is at its full-employment level of output (at the LRAS). engages in contractionary monetary policy, what will be the effect If the Federal Reserve on the interest rate, planned investment, and output? Show the change using the money market, planned investment graph and the aggregate expenditure model Show the short-run change using AD-AS. (There is no need to show additional changes to the money market or aggregate expenditure model.) Indicate all changes in relevant variables. What will happen to the price of bonds? (extra credit) What will happen to the price of the Euro (in terms of dollars)? Please explain. Show the change in the long-run with the AD-AS model. a. b. c. e.

Answer 1

If the Federal Reserve engages in contractionary monetary policy, it leads to a decrease in the money supply in the economy accompanied with an increase in interest rate, decrease in planned investment, and a decrease in output in the economy.

a.

AD AD- Y ㅡㅡ AD V AD 5, o 1s 0 → Inconnu

b.  

LRAS SRAS PICE LeveL SRAS SRAS AD

It leads to a decrease in output and a shift in AD from AD to AD'.

c. Due to the contactionary monetary policy, the Fed will decrease the money supply in the economy. This will lead to selling out bonds by Fed. As the interest rates have rise, it will lead to increase in the prices of bonds because people will want to hold less money.

d. Due to contractionary monetary policy, people will demand more of domestic currency ($) than foreign currency (euro). So this will lead to an increase in the exchange rate. Therefore, the price of domestic currency ($) will increase and that of foreign currency (euro) will decrease.

e.

LRAS LRAS ら RIcE SRAS AD Output onbleymant