Consider the scenario in which the Fed is implementing a contractionary monetary
ID: 1202251 • Letter: C
Question
Consider the scenario in which the Fed is implementing a contractionary monetary policy aimed at alleviating inflationary pressures.In this regard please provide an answer to the questions listed below. In order to answer, it might be a good idea to use a money market diagram and show how interest rates affect the economy using the AD/AS diagram. No need to submit the graphs, but once again drawing the two graphs (money market and AD/AS) for yourself will go a long way in guiding you towards the right answer. Note. In the static AD/AS model, initially assume that the economy is in SR equilibrium and real GDP is above potential GDP. a) As a result of the contractionary monetary policy pursued by the Fed, what would happen with the interest rate? The interest rate is going to (rise/fall/stay fixed) Blank 1 . b) What would happen with the short run aggregate supply curve? Short run aggregate supply curve will shift (left/right/stay fixed) Blank 2 . c) What would happen with the long run aggregate supply curve? Long run aggregate supply curve will shift (left/right/stay fixed) Blank 3 . d) What would happen with the aggregate demand curve? Aggregate demand curve will shift (left/right/stay fixed) Blank 4 . e) What would happen with the Real GDP level? Real GDP will (rise/fall/stay fixed) Blank 5 . f) What would happen with the employment level? Unmployment level will (rise/fall/stay fixed) Blank 6 .Explanation / Answer
(a) Due to contractionary monetary policy, interest rate will rise (Because LM curve will shift leftward, due to lower money supply).
(b) As LM shifts left, short run aggregate supply stays fixed (SInce change in LM does not affect aggregate supply).
(c) Long run aggregate supply will remain Fixed.
(d) Aggregate demand will shift Left (lower money supply will reduce aggregate demand).
(e) As aggregate demand shifts leftward, real GDP will fall.
(f) Unemployment level will rise (Lower real GDP will lower demand for labor, resulting in lower employment).