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The Federal Reserve expands the money supply by 5 percent. a. Use the theory of
Chapter 34, Problem 2(choose chapter or problem)
The Federal Reserve expands the money supply by 5 percent.
a. Use the theory of liquidity preference to illustrate in a graph the impact of this policy on the interest rate.
b. Use the model of aggregate demand and aggregate supply to illustrate the impact of this change in the interest rate on output and the price level in the short run.
c. When the economy makes the transition from its short-run equilibrium to its long-run equilibrium, what will happen to the price level?
d. How will this change in the price level affect the demand for money and the equilibrium interest rate?
e. Is this analysis consistent with the proposition that money has real effects in the short run but is neutral in the long run?
Questions & Answers
QUESTION:
The Federal Reserve expands the money supply by 5 percent.
a. Use the theory of liquidity preference to illustrate in a graph the impact of this policy on the interest rate.
b. Use the model of aggregate demand and aggregate supply to illustrate the impact of this change in the interest rate on output and the price level in the short run.
c. When the economy makes the transition from its short-run equilibrium to its long-run equilibrium, what will happen to the price level?
d. How will this change in the price level affect the demand for money and the equilibrium interest rate?
e. Is this analysis consistent with the proposition that money has real effects in the short run but is neutral in the long run?
ANSWER:Step 1 of 6
a. The increase in the money supply will cause the equilibrium interest rate to decline. Households will increase spending and will invest in more new housing. Firms, too, will increase investment spending. This will cause the aggregate demand curve to shift to the right, showing the quantity of output and Price level.