1. Practice with the best case: You are the central banker, and you have to deci
ID: 1111525 • Letter: 1
Question
1. Practice with the best case: You are the central banker, and you have to decide how fast the money supply should grow. Your economy gets hit by the following AD shocks and your job is simply to neutralize them: Just push money growth in the opposite direction of the shock. In all of the cases below, assume that there's no change whatsoever to the Solow growth rate, and assume that before the shock, you're at your optimal inflation rate and optimal real growth rate. (Yes, this really is the best case!) These are all shocks, so think of each case study below as preceded by the word, "Suddenly. . . ." Given the shocks to , should the central bank react by raising money growth or by cutting money growth?i. Investors become pessimistic about future profit opportunities.
ii. State governments increase spending on schools, prisons, and health care. raise in i, lower in ii lower in i, raise in ii lower in both i and ii raise in both i and ii
Explanation / Answer
In the first case when investors are pessimist they will reduce investment spending. To influence in stimulate aggregate demand and increase in money growth rate is required. Similarly when is state governments are increasing their expenditure it would already stimulate the aggregate demand so there is no need to have additional money growth which means the central bank can reduce money growth to maintain long run equilibrium. Hence the central bank should RAISE IN FIRST AND LOWER IN SECOND. OPTION ONE IS CORRECT.
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