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Question

1. The FED is predicting that next year higher AD could cause GDP to rise to $12


Trillion

with an unemployment rate of 4%, even though it is estimating that


Potential GDP = $11 Trillion and the natural rate of unemployment is 6%.


A. Draw an AS/AD depicting the current prediction from the FED and where


the economy would be if GDP =$12 Trillion (You should include AD, SRAS


and LRAS, make sure you correctly label the axes as well). Label that point


"A."


B. If the FED decides to not use policy, where would the economy eventually


end up? Label that point "B" and indicate what happens to GDP, UE and P.


Explain how the economy moves from A to B.


C. If the FED instead decides to enact Monetary Policy (starting at A), indicate


the steps that they would take. Show where the economy would end up on


your graph and label that point "C." Explain the steps that cause the economy


to change and indicate what happens to GDP, UE and P as you move from


point A to C.


D. Is the policy the FED chose in C expansionary or contractionary. What


"goal" is the FED trying to achieve with its policy?


E. If the Government instead tried to enact fiscal policy (starting at A),


indicate the steps they would take. Show where the economy would end up


on your graph and label that point "D." Explain the steps that cause the


economy to change and indicate what happens to GDP, UE and P as you move


from A to D.


F. What additional goal can the Govt achieve by enacting fiscal policy in this


case? (hint...think about the govt budget)


2. The Fed decides to buy $50 million in bonds.


A. Show the initial T-account at the bank when this gets deposited.


B. If the Reserve Requirement is 25%, show the T-account after the first


loan is made.


C. What is the maximum amount the money supply could expand by from


this purchase. Show the T-account if the maximum number of loans and


deposits is made.


D. Show the affect of the change in the Money Market (your numbers don't


have to be precise, just show the change to the equilibrium.)


E. Assume this purchase ultimately increased the overall money supply by


5%, if the growth rate of GDP was 2%, calculate the expected change to


inflation in the long run.


F. What are the other two ways the FED could have increased the money


supply?

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