suppose the following table illustrates the values of real and potential GDP and
ID: 1110793 • Letter: S
Question
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 their 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 goals?
Year Potential Real GDP Real GDP Price Level 2016 $18.1 trillion $18.1 trillion 150 2017 18.4 trillion 18.3 trillion 153Explanation / Answer
Answer - The Federal Reserve Bank is does not vote to change their current policy. In 2016 we can see real GDP ($18.1 trillion) is equal to potential real GDP ($18.1 trillion). Price level in the 2016 is 150. The economy is in equilibrium in 2016. Real GDP ($18.3 trillion) is less than potential real GDP ($18.4 trillion). We can see that price level has increased to 153 from 150 in 2017.
Fed should use more expansionary monetary policy to reach the potential real GDP level. Fed conducts open market operations in order to affect money supply in the economy. In open market operations, Fed sells and purchases government securities in the open market to commercial banks.
If Fed wants to use more expansionary monetary policy then it purchase government securities from commercial banks in open market. It result more availability of funds to banks, these banks distribute more loans and money supply will increase in the economy by this way.
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