Chapter 24: Problem 13

Suppose the Federal Reserve begins to increase the supply of money at an increasing rate. What impact would that have on GDP, unemployment, and inflation?

Short Answer

Expert verified

In summary, when the Federal Reserve increases the money supply at an increasing rate, it leads to lower interest rates, which encourage businesses to invest more and consumers to spend more. This increases GDP and decreases unemployment. However, it also results in higher inflation, which can be problematic if it outpaces real GDP growth.

Step by step solution

Understand the effect of increased money supply on interest rates

An increase in the supply of money can be caused by the Federal Reserve buying government bonds or lowering the reserve requirements for banks. When the money supply increases, the amount of money available in the economy exceeds the demand for money. As a result, the cost of borrowing money (the interest rate) decreases.

Analyze the effect of decreased interest rates on investments and consumption

Lower interest rates encourage businesses to invest more and consumers to spend more, as the cost of borrowing money decreases. When businesses invest more, they can expand their production capabilities and hire more workers. When consumers spend more, they increase the demand for goods and services.

Observe the impact of increased investments and consumption on GDP

Gross Domestic Product (GDP) is a measure of the value of all goods and services produced in an economy. An increase in investments and consumption will result in more goods and services being produced, which will directly lead to an increase in the GDP.

Identify the effect of increased investments and consumption on unemployment

When businesses invest more and expand their production capabilities, they will hire more workers to meet the increased demand. This increase in hiring will lead to a decrease in unemployment.

Examine the relationship between increased money supply, GDP, and inflation

As GDP increases, the demand for goods and services increases, causing an increase in prices (inflation). As the Federal Reserve increases the supply of money at an increasing rate, inflation may continue to rise if the money supply continues to grow faster than the real growth in GDP. In conclusion, increasing the money supply at an increasing rate would likely lead to an increase in GDP and a decrease in unemployment. However, it would also lead to an increase in inflation, which could become problematic if it continues to rise at a faster rate than real growth in GDP.