Suppose that the Fed has a policy of increasing the money supply when it observe

Question

Suppose that the Fed has a policy of increasing the money supply when it observes that the economy is in recession. However, suppose that about six months are needed for an increase in the money supply to affect aggregate demand, which is about the same amount of time needed for firms to review and reset their prices. What effects will the Fed's policy have on output and price stability? Does your answer change if (a) the Fed has some ability to forecast recessions or (b) price adjustment takes longer than six months?

Explanation / Answer

the economy is in recession. However, suppose that about six months are needed for an increase in the money supply to affect aggregate demand, which is about the same amount of time needed for firms to review and reset their prices. that technically does not affect the AD curve. Just because the government decides to reduce spending, it doesn't necessarily mean that there would be increased spending elsewhere or that the government is going to cut back taxes for the benefit of the consumers, unfortunately. In which case, the AD does not move.
On the other hand, if you consider military spending on producing military goods is a part of SRAS, which I think it shouldn't (we do not produce weapons of mass destruction and then sell them on as people have us believe), then the SRAS should shift to the left. because it will create multiplier effects, even when it is done only to inspire people. On the contrary, the tax cut for the guys above 250K to stimulate employment and investment is a supply side economics.In that case I might choose A.

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