APEcon
12-13
Name:______________________________
Monetary Policy Questions- Answers
1) Suppose the economy begins in long-run macroeconomic equilibrium. What is the long-run
effect on the aggregate price level of a 5% increase in the money supply? Explain.
The concept of MONEY NEUTRALITY explains that any increase in the money supply will result in an
equal increase in price levels. So prices increase 5% in the long-run.
2) Again supposing the economy begins in long-run equilibrium, what is the short-run and long-run
effect on the interest rate if a 5% increase in the money supply occurs? Explain.
Short-Run- I.R. Decreases
Long-Run- I.R. doesn’t change because over time the demand for money increases to push the I.R. back
to its original level.
3) If the economy is in a recession and monetary policy is the preferred method for stabilizing the
economy.
a. What would you recommend the Federal Reserve do to stabilize this economy?
BUY BONDS
b. What would be the argument used by the opposition against the Fed’s policy?
Monetary policy is not as effective as the FED would like at stimulating the economy.
c. What would be a reason for the Fed’s policy to not achieve its goal of stimulating the
economy?
The FED can’t get businesses to borrow.
d. Explain the potential long-run consequences of the Fed’s action to fight the recession.
Expansionary Monetary Policy will most likely lead to higher prices in the long-run.
4) If the economy is suffering from severe inflationary problems and monetary policy is the
preferred method for stabilizing the economy.
a. What would you recommend the Federal Reserve do to stabilize this economy? Explain
the effect.
SELL BONDS- This will increase the IR and slow borrowing and spending releasing pressure on
prices.
b. Do you think that opposition to monetary policy would be as vocal to fighting the
inflation? Why or why not?
NO, the fed has proven it can effectively minimize the inflationary effects over time.
5) Suppose in the United States the Fed is targeting a Federal Funds rate equal to 5%.
a. How would the Fed achieve this if the current Federal Funds rate was equal to 4%?
APEcon
12-13
Name:______________________________
SELL Bonds to increase the M.S.
b. Draw a money market graph showing this change.
M.S. Curve would shift left.
c. What type of impact would this have on Aggregate output and aggregate price levels in
the short-run? Explain.
Aggregate Output- Decrease
Aggregate Price Level- Decrease