Question

Describe the effects of contractionary monetary policy by the domestic central bank on output, the real interest rate, and net exports in both the domestic and foreign country, using a Keynesian model in the short run. What happens in the long run?

(Word Limit: 100 words)

Answer 1

The Keynesian study focuses on short-run analysis. Thus, contractionary fiscal policy would cause a fall in the aggregate demand in the economy. Fall in the aggregate demand would drag down the output level as well. There will be a decline in the demand for money, so the interest rate will also decline.

The outflow of fund will lead to fall in the value of currency or there will be depreciation. Depreciation will drive up net export of country. Import will be costly, thus foreign country will witness decline in net export.

Keynesian economists argue that economy is in equilibrium over the long run, or economy comes to the equilibrium even without government intervention. Government intervention is required over the short run only.