2. Describe whether the following statements are true or false. Justify your ans

Question

2. Describe whether the following statements are true or false. Justify your answer. (a) Suppose there is a decrease in the price level. Given the stock of nominal money, M, this leads to an increase in the real money stock, M, which shifts the LM curve down. This implies that the AD curve shifts to the right. (b) A horizontal AS curve assumes complete price stickiness. (c) The Keynesian case holds that AS is vertical. (d) It is not possible for expansionary monetary policy to boost output in the short run. (e)A country with a fixed exchange rate is unable to use fiscal policy to change the level of output (Y) (f) In the short run, prices are sticky and thus inflation is equal to zero. Then, by Fisher effect, we can conclude that nominal interest rate is equal to real interest rate.

Explanation / Answer

First statement is true. A fall in the price level will increase the real money supply and this will shift the LM curve down to the right and this will shift the aggregate demand curve to the right. This happens because interest rates are reduced and this increases investment spending.

Second statement is true because aggregate supply curve is drawn for prices and if prices do not change in the short run aggregate supply curve becomes horizontal.

The third statement is wrong because keynesian case considers aggregate supply to be horizontal due to prices stickiness

IV statement is also incorrect because expansionary monetary policy increases the money supply and shifts the aggregate demand curve to the right. This reduces interest rate and increases the price level along with an increase in the output.

A country that has fixed exchange rate cannot use its monetary policy to influence the output which means it has only fiscal policy which is effective. Therefore V this statement is also in correct.

The last statement is incorrect. When we say that prices are sticky we do not mean that inflation is zero. It implies that there is no change in the rate of inflation and so it moves with the same inertia

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