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What is the main difference between a demand shock stemming from monetary policy and a demand shock that comes from a change in spending?

A) In the short-run, an autonomous monetary policy easing lowers real interest rates and raises aggregate output whereas a positive spending shock has the opposite effect on both variables.

B) An autonomous monetary policy easing raises inflation permanently whereas a positive spending shock only raises inflation temporarily.

C) An autonomous monetary policy easing has a temporary effect on the real interest rate whereas a positive spending shock has a permanent effect on the real interest rate.

D) all of the above

E) none of the above

 

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Joshua Stredder
Joshua StredderLv10
26 Sep 2020

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Related questions

2. Suppose instead, real GDP in the United States falls temporarily instead. Contrast the immediate effect of the temporary shock on interest rates and the exchange rate compared to the permanent shock.

a. (20 points) Draw two diagrams with the money market diagram for the US on the left and the expected return in $/ exchange rate ($/yen) diagram on the right. Label the impact effect, when the shock is temporary, as point B and the impact effect when the shock is permanent as point C.

b. (5 points) Why are these impact effects on the exchange rate different? Explain.

c. (5 points) Assuming again that the shock to real GDP in the US was temporary, what would happen to the nominal interest rate in the US and the exchange rate in the long-run. Explain.

3. Denmark pegs their currency, the krone, to the euro.

a. (10 points) Draw two diagrams, side by side with the money market diagram for Denmark on the left and the expected return in krone / exchange rate diagram on the right hand side. Label the initial equilibrium point A. Denmark suffers from an adverse productivity shock and goes in a recession. Show how your two diagrams are affected by the recession in Denmark. Assume that the peg is credible. b.

b) (10 points) Suppose Denmark prefers to fight the recession via counter-cyclical monetary policy by increasing the money supply in hopes of lowering interest rates in Denmark. Explain what would happen...i.e., would they be successful or not? Be sure to mention capital flows and use the term(s) 'capital flight' and/or 'hot money,' whichever applies. Make sure to use a balance sheet - T - account for Denmark's central bank and show/explain how the money supply changes endogenously.

  1. If the Fed lowers the federal funds rate using an open market sale, what will be the effect on other interest rates? The exchange rate? Money and bank loans? Long-term real interest rate? Expenditure plans? Aggregate demand?

  1. What limits the Fed's ability to steer the economy to avoid both recession and inflation?

  1. Why is there a difference between the short-run and long-run effects from an increase in the quantity of money?

  1. Why must the Fed decide to target either the interest rate or the monetary base? Why can't the Fed determine acceptable values for both and then use open market operations to hit both targets?

  1. What are the benefits of using rules to conduct monetary policy?

MBA502, Economics for Business

Apply and Discover 7.2

You are responsible for economic policymaking in your country. Your desire is to eliminate inflation, keeping prices absolutely stable at P = 100, no matter what happens to output. Currently, the economy is in equilibrium at Q = 3200 (where Q = potential GDP) and P = 100. You can use monetary and fiscal policies to affect aggregate demand but you cannot affect aggregate supply in the short run. How would you respond to the following scenarios?

Explain and illustrate how each of these events would affect aggregate demand, aggregate supply, and prices, then explain how you would respond with economic policies.

1. A surprise increase in investment spending

In the short run, when investment spending increases, it results in an increase in Aggregate Demand (AD), which in turn pushes up both GPD and the price index.

To counterbalance this development, government might pursue contractionary fiscal policy by increasing taxes (to reduce consumption) or decreasing its own investment and spending so that the AD curve shifts back to its original position. Alternatively, the government can pursue contractionary monetary policy by reducing money supply and increasing interest rate to discourage economic activity.

2. Catastrophic floods that cause a sharp food price increase

In this case, sharp food shortages and consequent price increases cause a shock-type adjustment of the aggregate supply curve (it shift up and to the left). The result is a lower GDP and a higher price level.

The government cannot do anything to adjust AS in the short run. However, if the goal is to maintain the price level constant, the government can decide to do something to decrease the aggregate demand to force prices to come down, though it will be accompanies by another contraction in GDP and so it would not be a smart thing to do.

To cause AD to decrease, the government, similar to example above, can pursue fiscal policy (increase taxes, decrease spending) or monetary policy (reduce supply of money to the economy and thus increase interest rates).

3. A productivity decline that reduces potential output

In this case, AS shifts to the left, as was the case in example 2. As a result, price levels go up, as the same amount of money is chasing the reduced amount of goods and services, and GDP declines.

Government remedies here would be centered about causing AD to decrease through contractionary fiscal (higher taxes, lower spending) or monetary (reduce money supply and increase interest rates) policy. Again, this decision reduces inflation but at expense of GDP, as real output shrinks further.

4. A deep depression in East Asia that causes a sharp decrease in net exports to the United States

A decrease in exports of goods to from the United States to Asia will mean that the aggregate demand (which includes net exports

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