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Chapter 22: Q.7 (page 582)

Suppose that a new Fed chair is appointed and that his or her approach to monetary policy can be summarized by the following statement: "I care only about increasing employment. Inflation has been at very low levels for quite some time; my priority is to ease monetary policy to promote employment." How would you expect the monetary policy curve to be affected, if at all?

Short Answer

Expert verified

"If prices and wages are totally flexible, then gammay = 0 Y and changes in aggregate demand have the smallest influence on output," according to the supplied statement. is true.

Step by step solution

01

Step 1. Concept of Perfectly flexible pricing 

Perfectly flexible pricing are those that are altered as a result of negotiations between buyers and sellers. Wages that are perfectly flexible are those that are affected by changes in demand and supply. The overall demand for goods and services produced in an economy is referred to as aggregate demand (AD).

02

Step 2. Explanation

The stated assertion is correct. Perfectly flexible wages and prices bring Y close to zero and allow the AD to have a minor impact on output.

More flexible salaries and pricing reflect the fact that the economy's demand and supply are constantly changing. These modifications and negotiations by both buyers and sellers have a smaller impact on the value of Y, and Y is not equal to 0 in this situation.

The aggregate demand curve also grows steeper when it adjusts over a short period of time due to the effect of flexible pricing and flexible wages. The output is affected by a steeper aggregate demand curve, although the effect is not significant.

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Most popular questions from this chapter

Suppose the MP curve is given by r=2+πand the IS curve is given by Y = 20 - 2r.

a. Derive an expression for the AD curve, and draw a graph labeling points at π=0,π=4,π=8

b. Suppose that λincreases to λ=2. Derive an expression for the new AD curve, and draw the new AD curve using the graph from part (a).

c. What does your answer to part (b) imply about the relationship between a central bank’s distaste for inflation and the slope of the AD curve?

Assume that the monetary policy curve is given by

r = 1.5 + 0.75p.

a. Calculate the real interest rate when the inflation rate

is 2%, 3%, and 4%.

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 + 0.75p. 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

is 2%, 3%, and 4%, and draw the new MP curve,

showing the shift from part (b).

"Autonomous monetary policy is more effective at changing output when λ is higher." Is this statement true, false, or uncertain? Explain your answer.

What is the key assumption underlying the Fed’s ability to control the real interest rate?

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).
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