One of the tasks with which the Fed is charged is maintaining the health of the

Question

One of the tasks with which the Fed is charged is maintaining the health of the economy. The Fed achieves this through monetary policy, changing the money supply.

Describe the steps through which changes in the money supply affect RGDP. (6 points)

Explain why monetary policy may fail to affect RGDP due to the characteristics of (Hint: Consider the effect of the slope of the relevant curve in each of the questions below):

The money market (3 points)

Investment demand (3 points)

Aggregate supply (3 points)

Explanation / Answer

An increase in money supply shifts the money supply curve to the right, which leads to a fall in interest rate. A lower interest rate increases investment. An increase in investment shifts the AD curve to the right, so the new AD interesects the AS curve at a point where the real GDP is higher.

If the money demand curve is almost flat in the money market, then a shift in the money supply curve has little or no effect on the interest rate, redering the monetary policy virtually ineffective.

If the investment demand curve is quite steep, then a fall in interest rate has has little or no effect on investment, rendering the monetary policy almost ineffective.

If the aggregate supply curve is vertical, a shift in AD only results in a rise in the price level and no change in the Real GDP. In fact, aggregate supply curve is vertical in the long run, implying that monetary policy has no effect on the real GDP in the long-run.

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