Why does the MP curve necessarily have an upward slope?

Short Answer

Expert verified

The MP curve slopes upward thanks to positive relationship of rate and real rate of interest. Positive relationship means increase in rate ends up in increase in real rate or contrariwise.

Step by step solution

01

Concept introduction 

MP curve shows the connection between the rate and real rate of interest. the 000 rate of interest takes rate into consideration and increase with increase in rate or contrariwise.

02

Explanation of solution 

MP curve equation is :

r=r¯+λπ

Where,

-ris Real interest rate.

-risAutonomous component.

-λis Responsiveness of the real interest rate to the inflation rate.

-πis Inflation rate.

Inflation is that the overall increase generally indicator of an economy. Inflation causes increase within the price of products and services which decreases the purchasing power of an economics agent.

This relationship must be positive because otherwise an increase in inflation would result into a fall in real interest rates, which might result into a rise in output, an extra increase in inflation, and an extra fall in real interest rates which might cause even higher inflation.

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Most popular questions from this chapter

Assume that the monetary policy curve is given byr=1.5+0.75π.

a. Calculate the real interest rate when the inflation rate is2%,3%,and4%.

b. Draw a graph of the MP curve, labeling the points from part (a).

c. Assume now that the monetary policy curve is given by r=2.5+0.75π.Does the new monetary policy curve represent an autonomous tightening or loosening of monetary policy?

d. Calculate the real interest rate when the inflation rate is2%,3%,and4%, and draw the new MP curve, showing the shift from part (b).

Suppose the monetary policy curve is given by r=1.5+0.75π, and the IS curve is given by Y=13-r.

a. Calculate an expression for the aggregate demand curve.

b. Calculate the real interest rate and aggregate output when the inflation rate is 2%, 3%, and 4%.

c. Draw graphs of the IS, MP, and AD curves, labeling the points from part (b) on the appropriate graphs.

A measure of real interest rates can be approximated by the Treasury Inflation-Indexed Security, or TIIS. Go to the St. Louis Federal Reserve FRED database, and find data on the five-year TIIS (FII5) and the personal consumption expenditure price index

(PCECTPI), a measure of the price index. Choose “Quarterly” for the frequency setting for the TIIS, and choose “Percent Change From Year Ago” for the unitssetting on (PCECTPI). Plot both series on the samegraph, using data from 2007 through the most currentdata available. Use the graph to identify periods of autonomous monetary policy changes. Briefly explain your reasoning.

How is an autonomous tightening or easing of monetary policy different from a change in the real interest rate caused by a change in the current inflation rate?

What factors affect the slope of the aggregate demand curve?

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