List and briefly explain the steps in how monetary policy affects real GDP in the AS/AD model using as your example the case when the Fed eases monetary policy to fight a recession
What will be an ideal response?
There are several steps. Step one is a change in the federal funds rate. To fight a recession, the Fed lowers the federal funds rate. It does so by using open market operations to increase banks' reserves. With the increase in reserves, the quantity of money and bank loans increase. The increase in loans increases the supply of loanable funds, which then lowers the real interest rate. Next the fall in the real interest rate increases investment, net exports (though a fall in the exchange rate), and other interest sensitive parts of aggregate demand and thereby increases aggregate demand. Aggregate demand increases with a multiplied effect. The increase in aggregate demand raises the price level and increases real GDP.
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If an economy's investment outlook improves, leading to increased borrowing to finance new building projects, what is likely to happen to interest rates?
a) Interest rates will fall to 0%. b) Interest rates will fall. c) Interest rates will rise. d) Interest rates will stay the same.
An increase in the expected price level
A) shifts the short-run aggregate supply curve up and to the left. B) shifts the short-run aggregate supply curve down and to the right. C) has no effect on the short-run aggregate supply curve. D) results in a movement along the short-run aggregate supply curve, rather than a shift in the short-run aggregate supply curve.