Worksheet 6 - Answer Key

Worksheet 6 - Answer Key - Introduction to Macroeconomics...

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Introduction to Macroeconomics Econ 104a,c,d,e,f, - Spring 2010 Answer Key Worksheet 6 – Monetary Policy 1. How does expansionary monetary policy affect the economy in theory? Money Supply increases Interest rates fall Investment rises Income rises. For graphs describing the relationships between these variables, see pg 414-418. 2. What is Fiscal Policy? How does it affect the economy in theory? Fiscal Policy is the increase or decrease of government spending or taxes. By increasing government spending and/or decreasing taxes, fiscal policy can have an “expansionary effect” – increasing aggregate demand (pushing AD curve up, to the right) and therefore increasing GDP and employment (but also causing inflation). Decreasing government spending and/or increasing taxes will theoretically have the opposite effect – a “contractionary effect” – decreasing aggregate demand (pushing the AD curve down and to the left), thereby decreasing GDP and employment levels, causing deflation. 3. Why did Keynes believe that Fiscal Policy was more powerful/effective than Monetary Policy? While Monetary policy, by effecting interest rates, can, in a more or less healthy economy, have an effect on investment and therefore can have a positive effect on GDP, it will not work as well as fiscal policy during a severe recession 4. What is the Liquidity Trap? Are we in one now? What does this mean for monetary policy? A ‘liquidity trap’ is when the demand curve for money is very flat, meaning that no matter how much the supply of money increases, it will have no effect on interest rates and/or investment. This occurs because people do not want to invest at all, because confidence in the economy has fallen so low. [Some say we are in a liquidity trap now.] This means Monetary policy in effectively taken out of the game. SEE PAGE 418 for a diagram.
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This note was uploaded on 11/30/2011 for the course ECON 104 taught by Professor Dolenc during the Fall '08 term at UMass (Amherst).

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Worksheet 6 - Answer Key - Introduction to Macroeconomics...

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