ECONOMICS 1120170 - SHORTANSWER. 173 ,,thaninarecession

ECONOMICS 1120170 - SHORTANSWER. 173 ,,thaninarecession

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Unformatted text preview: SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 173) Would the Federal Reserve respond more aggressively with interest rate cuts in a recession caused by a decrease in spending, as in the 2001 recession, than in a recession caused by an increase in oil prices, as in the 1974-75 recession? 173) Answer: The inflation rate responds differently in the two recessions. A large increase in oil prices decreases real GDP (or slows down the growth rate), but increases inflation. The large decrease in spending decreases real GDP and decreases inflation. The Fed wants to increase real GDP, but they also want to prevent an increase in inflation. Cutting interest rates increases aggregate demand which increases real GDP and increases inflation. With a recession caused by a drop in spending, the rate of inflation declines, which allows the Fed to more aggressively cut interest rates. Page Ref: 914-915/532-533 Learning Outcome: Macro-12: Explain how monetary policy influences interest rates, aggregate demand, real GDP and inflation. Table 15-4 Year 2016 2017 Potential Real GDP $18.1 trillion 18.4 trillion Real GDP $18.1 trillion 18.3 trillion Price Level 150 153 174) Refer to Table 15-4. Suppose the following table illustrates the values of real and potential GDP and the price level if the Fed does not vote to change their current policy to be more contractionary or expansionary. If the Fed wants to keep real GDP at its potential level in 2017, should the Fed use a contractionary or expansionary policy? How should it conduct open market operations to achieve its goal? Answer: The information in the table indicates that if the Fed does not vote to change their current policy to be more contractionary or expansionary, then real GDP will fall below potential GDP in 2017. To keep the economy at potential GDP in 2017, the Fed should use expansionary monetary policy. This would mean that the Fed should direct the trading desk to buy U.S. Treasury bills. If this is done, reserves in the banking system will increase, banks can increase the number of loans, and this should raise the money supply and lower the interest rate. Page Ref: 915-917/533-535 Learning Outcome: Macro-12: Explain how monetary policy influences interest rates, aggregate demand, real GDP and inflation. 54 174) Table 15-5 Year 2016 2017 Potential Real GDP $18.4 trillion 18.7 trillion Real GDP $18.4 trillion 18.5 trillion Price Level 144 146 175) Refer to Table 15-5. Suppose the table above illustrates the values of real and potential GDP and the price level if the Fed does not vote to change their current policy to be more contractionary or expansionary. Suppose that the Fed uses an appropriate policy and is successful in keeping real GDP at potential in 2017. State whether each of the following will be higher or lower than if the Fed had taken no action: a. Real GDP b. Potential real GDP c. The price level d. The unemployment rate 175) Answer: If the Fedʹs policy was successful, real GDP in 2017 will rise from $18.5 trillion to the level of potential GDP in 2017 which is $18.7 trillion. Potential GDP is not influenced by monetary policy so it should stay at $18.7 trillion. Since expansionary monetary policy increases AD, the short-run equilibrium will move up the short-run aggregate supply curve and the price level will be higher. Finally, because the level of real GDP is higher with policy, the unemployment rate will be lower than it would have been without the change in policy. Page Ref: 915-917/533-535 Learning Outcome: Macro-12: Explain how monetary policy influences interest rates, aggregate demand, real GDP and inflation. Table 15-6 Year 2016 2017 Potential Real GDP $18.1 trillion 18.4 trillion Real GDP $18.1 trillion 18.6 trillion Price Level 150 155 176) Refer to Table 15-6. Suppose the table above illustrates the values of real and potential GDP and the price level if the Fed does not vote to change their current policy to be more contractionary or expansionary. If the Fed wants to keep real GDP at its potential level in 2017, should the Fed use a contractionary or expansionary policy? Should it raise or lower its interest rate target? How should it conduct open market operations to achieve its goal? Answer: The information in the table indicates that if the Fed does not vote to change their current policy to be more contractionary or expansionary, then real GDP will rise above potential GDP in 2017. To keep the economy at potential GDP in 2017, the Fed should use contractionary monetary policy. The Fed should raise its interest rate target. This would mean that the Fed should direct the trading desk to sell U.S. Treasury bills. If this is done, reserves in the banking system will decrease, banks will decrease the number of loans, and this should lower the money supply and raise the interest rate. Page Ref: 915-917/533-535 Learning Outcome: Macro-12: Explain how monetary policy influences interest rates, aggregate demand, real GDP and inflation. 55 176) Table 15-7 Year 2012 2013 Potential Real GDP $14.2 trillion 14.8 trillion Real GDP $14.2 trillion 14.6 trillion Price Level 154 156 177) Refer to Table 15-7. Suppose the table above illustrates the values of real and potential GDP and the price level if the Fed did not vote to change their current policy to be more contractionary or expansionary. Suppose that the Fed used an appropriate policy and was successful in keeping real GDP at potential in 2013. Draw an aggregate demand and supply curve to illustrate your answer. Answer: The economy starts in equilibrium in 2012 at point A, with the SRAS 2012 curve intersecting AD 2012 along the LRAS 2012 curve. Real GDP is at its potential level of $14.2 trillion and the price level is at 154. Without a change in monetary policy, the AD 2012 curve shifts to AD 2013 (without policy) and the economy is in short-run equilibrium at point B. Because potential real GDP has increased from $14.2 trillion to $14.8 trillion, short-run equilibrium real GDP of $14.6 trillion is below the potential level. The price level has increased from 154 to 156. With policy, the AD 2012 curve shifts to AD 2013(with policy) and the economy is in equilibrium at point C. Real GDP is at its potential level of $14.8 trillion. We donʹt have enough information to be sure of the exact level of the new equilibrium price level. We do know that it will be higher than 156. It is shown rising to 158 in the graph. The inflation rate is 1.3% without policy and 2.6% with policy. 56 177) Page Ref: 913-914/531-532 Learning Outcome: Macro-12: Explain how monetary policy influences interest rates, aggregate demand, real GDP and inflation. 178) Use the dynamic aggregate demand and aggregate supply model and start with Year 1 in long-run macroeconomic equilibrium. For Year 2, graph aggregate demand, long-run aggregate supply, and short-run aggregate supply such that the condition of the economy will induce the Federal Reserve to conduct an expansionary monetary policy. Briefly explain the condition of the economy and what the Federal Reserve is attempting to do. Answer: The Federal Reserve conducts an expansionary monetary policy to increase real GDP to potential real GDP. In the graph below, the economy would move from point A in Year 1 to point B in Year 2 without any expansionary monetary policy. At point B, real GDP is below potential real GDP. The Fed would increase the money supply and lower interest rates to stimulate aggregate demand, trying to push the economy to reach potential real GDP. Page Ref: 915-917/533-535 Learning Outcome: Macro-12: Explain how monetary policy influences interest rates, aggregate demand, real GDP and inflation. Table 15-8 Year 2013 2014 Potential Real GDP $13.5 trillion 14.0 trillion Real GDP $13.5 trillion 14.4 trillion 57 Price Level 142 150 178) 179) Refer to Table 15-8. The hypothetical information in the table shows what the values for real GDP and the price level would have been in 2014 if the Federal Reserve did not use monetary policy: a. If the Fed wanted to keep real GDP at its potential level in 2014, should it have used an expansionary policy or a contractionary policy? Should the trading desk have bought T-bills or sold them? b. Suppose the Fedʹs policy was successful in keeping real GDP at its potential level in 2014. State whether each of the following would be higher or lower than if the Fed had taken no action: (i) Real GDP (ii) Full-employment real GDP (iii) The inflation rate (iv) The unemployment rate c. Draw an aggregate demand and aggregate supply graph to illustrate your answer. Be sure that your graph contains LRAS curves for 2013 and 2014; SRAS curves 2013 and 2014; AD curve for 2013 and 2014, with and without monetary policy actions; and equilibrium real GDP and the price level in 2014 with and without policy. Answer: a. The Fed should have used contractionary monetary policy. The trading desk needed to sell T-bills. b. If the Fedʹs contractionary policy was successful, real GDP in 2014 would be lower as would the inflation rate. Full-employment real GDP would not change and the unemployment rate would rise. c. The economy starts out in equilibrium in 2013 at point A. In 2014, with no contractionary monetary policy, the economy would go to point B with real GDP above potential real GDP and the price level at 150. Contractionary monetary policy would slow down the growth of aggregate demand and the economy would reach equilibrium at point C. 58 179) ...
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