Question

Macroeconomics Monetary Policy Questions

The below information shows that economy needs corrective actions by the Central Bank, which decided to use monetary policy. Year Actual Real GDP Potential GDP Price Level 2015 15.6 billion 15.8 billion 97 Answer the below questions: 1. If the Central Bank wants to keep real GDP at its potential level, should it use an expansionary or a contractionary monetary policy? 2. Explain the mechanism of that policy. Use the graph of Money demand and supply.

Answer 1

ANS 1

If central bank wants keep its real GDP at the potential GDP and the pontential GDP is more than real GDP then the central bank will use expansionary policy and interfere in the market. The examples of contractionary monetary policy is decrease in interest rate of loans, decrease in reserve requirements etc.

ANS 2

If the Central Bank uses expansionary monetary policy to attain the potential GDP in the market then it should use tools like decreasing interest rate and is central bank decreases the interest rate in the market then the people will lend more money from banks and there will be increase in money supply in the market and due to this increase in money supply in the market the people will demand more goods and so the GDP will increase to potential GDP and also the price level will also increase.

AD'= old aggregate demand

AD = new aggregate demand

P'= New price level

AUGUST 2012 2018 2 NUK Wednesday BE IN DAVstist APPOINTMENTS III AS Price > level 97 "AD Real GDP Potential GDP 2020/7/31 20:52

The real GDP is at 15.6 billion and potential at 15.8 billion and once the government uses expansionary monetary policy the demand increases anf AD shifts rightward and real GDP increases to potential GDP and price level increases to P'.