Introductory Macroeconomics: please wirte a clear answer for the question 2, at

Question

Introductory Macroeconomics: please wirte a clear answer for the question 2, at least 300 words.

Questions 1. Suppose that the election of a popular candidate suddenly increases people's confidence in the future. Use the model of aggregate demand and aggregate supply to analyse the effects on the economy 2. Suppose a wave of negative animal spirits overruns the economy, and people become pes simistic about the future. What happens to aggregate demand? If the Central Bank (or Fed) wants to stabilise aggregate demand, how shout it alter the money supply? If it does this, what happens to the interest rate? why might the Central Bank (or Fed) choose not to respond in this way? Preparation The slides and textbook readings will give you the basic framework of the ideas, theories and concepts you will need to complete the assignment. These notes may not be sufficient on their own. You will need to make use of additional reading and extra references in preparing your assignment. When you are taking notes for your assignment, try and 'translate' what the author is saying into your own words. Don't just copy out huge chunks from other people's work, otherwise they will probably end up in your assignment with very little of the wording changed (which is plagiarism).

Explanation / Answer

2.
When people become pessimistic, then their confidence in the economy decreases. It leads them to make less spending and aggregate demand decreases in the economy. Since, the aggregate demand drives the aggregate supply, then aggregate supply also comes down and more people become jobless. It further reduces the aggregate demand in the economy and aggregate demand moves in the leftward direction. To resolve this issue and stabilize the economy, the Federal Reserve (central bank) should implement expansionary monetary policy. As a part of it, the Federal Reserve, will increase in the money supply in the economy. It will be done by using different tools. The first tool is the open market operations. With this tool, FOMC will buy the government securities from the market and money will be injected in the economy. As a result, the money supply will increase. Another tool is to decrease the reserve requirements. With a decrease in reserve requirements, the bank will have more money for the loan disbursements. As a result, money supply will also increase.
With an increase in money supply, the interest rate will decrease. It will help households and firms to increase their consumption and investment expenditure due to lower interest rates. It will increase the aggregate demand in the economy and the economy will be able to revive.
Though the central bank or Fed may choose, not to follow this path due to a few reasons. The first reason is the liquidity trap where an increase in the money supply does not lead to the demand of money even if at a lower interest rate. It makes the monetary policy to be ineffective. So, the structural problems should be resolved at the same time when monetary policy is being implemented. The second reason is the crowding out effect, when the government sucks all the money available to the firms and households as a part of government spending and the economy does not get the benefits of the multiplier effect. Besides, there is an inside and outside lag also, affecting the effectiveness of the monetary policy. It makes Fed think rigorously about it.

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