Economics 2123A/B Lecture Notes - Lecture 14: Factors Of Production, Output Gap, Money Supply

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skycoyote197

19 Mar 2018

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Suppose the economy is initially in the following condition following a shock. The central bank could engage in monetary policy by setting the interest rate to r2 and closing the output gap. In order to do this they would have to increase the money supply which would also stabilize the price level. Remember if we draw the money market with the interest rate on the y axis instead of the price level then: So the new interest rate is r2. this means that interest is lower so investment and consumption are higher. If fiscal policy id used and the government spends in the current period the yd and ys will shift at the original interest rate. Investment will not increase , but consumption might be higher due to the higher y (income). If the centarl bank wants to hold the interest target money supply must be increased because more money is demanded when y increases.

Related Questions

Consider an economy where the production function is given by Y = K^(1/2)L^(1/2). The level of capital in the economy equals 400, and the number of employed workers is 225. Suppose the quantity of money in the economy equals 200, and the velocity of money circulation is constant and equals 5. Suppose initially the economy is in the long-run equilibrium.

1. Use the quantity theory of money to determine the aggregate demand in the economy.

2. Determine the equilibrium output and the price level in period 0.

3. Suppose in period 1 the central bank decreases money supply by 50. What will happen to output in the short-run?

4. Is monetary policy neutral in the short-run?

5. What will be the equilibrium price level and output after prices adjust to the shock?

6. Is monetary policy neutral in the long-run?

fuchsiamallard938

The U.S. Federal Reserve is the central bank of the United States. It has many roles in the economy, but one of its key roles is conducting monetary policy.

What is monetary policy?
Suppose the Fed wants to close an inflationary gap. How could it use each of the three tools of monetary policy to close the gap?
Using the monetary policy tool the Fed employs most often, the Fed closes an inflationary gap. Describe the steps the economy goes through to move to the new equilibrium output and price level. Use graphs with your answer and be sure to label everything completely.

violetbuffalo140

13. As we observed in this chapter, central banks, rather than purposefully setting the level of the money supply, usually set a target level for a short-term interest rate by standing ready to lend or borrow whatever money people wish to hold at that interest rate. (When people need more money for a reason other than a change in $4,010 $570.3 $641.0 CHAPTER 15 Money, Interest Rates, and Exchange Rates 383 the interest rate, the money supply therefore expands, and it contracts when they wish to hold less.) a. Describe the problems that might arise if a central bank sets monetary policy by holding the market interest rate constant. (First, consider the flexible-price case, and ask yourself if you can find a unique equilibrium price level when the central bank simply gives people all the money they wish to hold at the pegged interest rate. Then consider the sticky-price case.) b. Does the situation change if the central bank raises the interest rate when prices are high, according to a formula such as where a is a positive constant and a target price level? c. Suppose the central bankâs policy rule is where u is a random movement in the policy interest rate. In the overshooting model shown in Figure 15-12, describe how the economy would adjust to a permanent one-time unexpected fall in the random factor u, and say why. You can interpret the fall in u as an interest rate cut by the central bank, and therefore as an expansionary monetary action. Compare your story with the one depicted in Figure 15-13. Figure 15-12: http://gyazo.com/3d32377d42b5c9584e17b3c5e40aafaa

Figure 15-13: http://gyazo.com/1fa467e253e320f61da17532fa8d2b58

Economics 2123A/B Lecture Notes - Lecture 14: Factors Of Production, Output Gap, Money Supply

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