The monetarist transmission mechanism Suppose that, initial, the economy is oper
ID: 1188870 • Letter: T
Question
The monetarist transmission mechanism Suppose that, initial, the economy is operating with an inflationary gap and the Federal Reserve ("the Fed") pursues a contractionary monetary poky to dose the GDP. Assume that natural real GDP equals $2 trillion. The following graph shows the supply (S) and demand (0) curves in the money market. Show the effect of the contractionary monetary policy by dragging one or both curves. Tool tip: Click and drag one or both of the curves. Curves will snap into position, so if you try to move a curve and it snaps back to its original position, Just try again and drag it a little farther.Explanation / Answer
When a contractionary monetary policy is followed, the interest rate increases and quantity of money in the economy falls. This would shift the supply curve of money to the left. The new equilibrium would be at higher rate with lower quantity of money.
A contractionary monetary policy will lead to fall in Aggregate demand, a leftward shift. Increased interest rate means lower investment as loans will be more expensive. The price level would come down and GDP will fall.This is kenesian and monetarist view. However keynesian thinks monetary policy is ineffective only fiscal policy is effective. Monetarist believe that monetry policy is effectiev and fiscal plicy is ineffective.
Neither kenesian nor monetarist believe that monetary policy affects the aggregate supply.
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