Suppose that each 0.1 percentage point decrease in the equilibrium interest rate

Question

Suppose that each 0.1 percentage point decrease in the equilibrium interest rate induces a $10 billion increase in real planned investment spending by businesses. In addition, the autonomous spending multiplier is 2 2 and the money multiplier is equal to 3 3. Furthermore, every $20 billion increase in the money supply brings about a 0.1 percentage point reduction in the equilibrium interest rate.

How much must real planned investment increase if the Fed desires to bring about a $ 200 billion increase in real GDP? $ ______.(Round your answer to a whole number.)

What dollar amount of open market operations must the Fed undertake to bring about the money supply change necessary to bring about a $ 200 200 billion increase in real GDP?_______.(Round your answer to a whole number.)

Explanation / Answer

Spending multiplier is to 2. Recessionary gap is 200. This indicates that we need to increase the investment spending by 200 / 2 which is 100 bilion. Because at 10 billion dollar increase in the investment is corresponded with all 0.1 percentage decrease in interest rate, we need 1% decrease in the interest rate to increase the investment by 100 billion which will then increase the GDP by 200 bilion.

When interest rate is reduced by 1 % a total of 200 bilion increase is required in the money supply. Because money multiplier is 3, we need to have a total of 200 / 3 or 68 billion increase in the open market purchase.

The two answers are 100 billion and 68 billion.

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