2. Graph above: Show the effect of the Fed\'s contractionary monetary policy by

Question

2. Graph above: Show the effect of the Fed's contractionary monetary policy by shifting one or both of the curves, and ignore any potential feedback effects.

5. When the Fed sells bonds, the amount of money in circulation in the economy (increases/ decreases). This drives interest rates (up/ down), which causes businesses to invest (more/less) in capital improvements such as new factories and upgraded equipment. The result is (an increase/ a decrease) in aggregate demand, (an increase/ a decrease) in the equilibrium price level, and (an increase/ a decrease) in the equilibrium level of real GDP.

4. The effect of monetary policy on aggregate demand Suppose the Federal Reserve ("the Fed") shifts to a contractionary monetary policy by selling bonds through open-market operations. Assume that this policy is unanticipated. This problem will work through the short-run effects of this move The following graph shows the money demand and money supply curves. Show the effect of the Fed's contractionary monetary policy by shifting one or both of the curves, and ignore any potential feedback effects. As a result of the Fed's policy, the interest rate ?to Money Supply Money Demand Money Supply 600900200 500 1800

Explanation / Answer

1. As a result of the Fed's policy, the interest rate rises to 4%.

5.  When the Fed sells bonds, the amount of money in circulation in the economy decreases. This drives interest rates up,  which causes businesses to invest less in capital improvements such as new factories and upgraded equipment. The result is a decrease in aggregate demand, a decrease in the equilibrium price level, a decrease in the equilibrium level of real GDP.

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