Log out Go to App
Go to App

Learning Materials

Features

Discover

Chapter 16: Q. 22 - Problems (page 370)

Take a look at Figure 16-6. Suppose that a multiple reduction in GDP is the final outcome that the Fed desires in the last box in the figure. Explain the required directions of efforts - that increases or decreases - that most occur in the preceding boxes in the figure in order to yield in this desired decrease in real GDP

Short Answer

Expert verified

Contractionary monetary policy reduces excess reserves & credit creation, liquidity in the economy. It increases interest rates & decreases investment, aggregate demand & real GDP

Step by step solution

01

Monetary Policy & Money Supply Concept 

Monetary Policy is the central bank's credit policy used to control money supply in the economy

  • Increase in Bank rate, Increase in Legal Reserve Ratio, Increase in Marginal requirement are credit & money, GDP contraction tools

They decrease the monetary (excess) reserves of commercial banks, which further decrease their credit creation capacity and money supply in the economy.

02

Interest Rates, Investment & Real GDP Concept 

  • Decrease in money supply (due to credit contraction monetary policy) lead increase in interest rates respectively, as interest is the price of money.
  • Increase interest rates implies corresponding decrease in investment.
  • Decrease in investment increases or decreases Aggregate Demand & real GDP (total value of goods & services in economy) further.

Unlock Step-by-Step Solutions & Ace Your Exams!

  • Full Textbook Solutions

    Get detailed explanations and key concepts

  • Unlimited Al creation

    Al flashcards, explanations, exams and more...

  • Ads-free access

    To over 500 millions flashcards

  • Money-back guarantee

    We refund you if you fail your exam.

Start your free trial

Over 30 million students worldwide already upgrade their learning with Vaia!

One App. One Place for Learning.

All the tools & learning materials you need for study success - in one app.

Get started for free

Most popular questions from this chapter

Assume that the following conditions exist :

a. All banks are fully loaned up - there are no excess reserves, and desired excess reserves are always zero.

b. The money multiplier is 3.

c. The planned investment schedule is such that at a 6percent rate of interest, the investment is \(1200billion; at 5 percent, investment is \)1225billion

d. The investment multiplier is 3.

e. The initial equilibrium level of real GDP is \(18trillion.

f. The equilibrium rate of interest is 6percent.

Now the Fed engages in expansionary monetary policy. It buys \)1billion worth of bonds, which increases the money supply, which in turn lowers the market rate of interest by 1percentage point. Determine how much money supply must have increased, and then trace out the numerical consequences of the associated reduction in interest rates on all the other variables mentioned.

Suppose that the Fed implements each of the policy changes you discussed in Problem 16-12. Now explain how the net export effect resulting from these monetary policy actions will reinforce their effects that operate through interest rate changes.

If the FOMC were to aim to attain targets for M1 or M2 instead of the federal funds rate, would people be as concerned with trying to anticipate future federal funds rate changes? Explain.

You learned in an earlier chapter that if there is an inflationary gap in the short run, then in the long run a new equilibrium arises when input prices and expectations adjust upward, causing the short-run aggregate supply curve to shift upward and to the left and pushing equilibrium real GDP per year back to its long-run value. In this chapter, however, you learned that the Federal Reserve can eliminate an inflationary gap in the short run by undertaking a policy action that reduces aggregate demand.

a. Propose one monetary policy action that could eliminate an inflationary gap in the short run.

b. In what way might society gain if the Fed implements the policy you have proposed instead of simply permitting long-run adjustments to take place?

Describe how Federal Reserve monetary policy actions influence market interest rates
See all solutions

What do you think about this solution?

We value your feedback to improve our textbook solutions.

Study anywhere. Anytime. Across all devices.

Sign-up for free