Question

4. (5 points) What effect a selling bonds will have on the money market? Explain using bond prices. 5. (7 points) Assume that fiscal policy can be accomplished by changing only one of G and T. the IS-LM framework, suppose the effect on the general equilibrium output is the same between expansionary fiscal policy and expansionary monetary policy. Which one would you expect to have a greater impact on the equilibrium consumption? Explain in words. Hint: Monetary policy affects also affects Y in the IS-LM framework!

Please answer and explain

Answer 1

Ques 4

One of the most direct ways for a central bank to increase or reduce the amount of money in circulation is via open market operations. Open market operations involve the purchase and sale of government bonds from and to commercial banks and/or designated market makers. For example, when the central bank buys government bonds from commercial banks, this increases the reserves of private sector banks on the asset side of their balance sheets. If banks then use these surplus reserves by increasing lending to corporations and households, then via the money multiplier process, broad money growth expands.
In using open market operations, the central bank may target a desired level of commercial bank reserves or a desired interest rate for these reserves.

At the point when the Federal Reserve purchases bonds, bond costs go up, which thus decreases interest rates.
The immediate impact of a bond cost increment on interest rates is most effortless to see. On the off chance that a $100 bond pays $5 every year in interest, at that point the interest rate on that bond is 5% every year. On the off chance that the bond cost goes up to $125, at that point $5 every year in interest is just a 4% interest rate.
Indeed, the impact of a bond value change is more grounded in light of the fact that the principal reimbursed toward the end additionally stays steady. Assume that the bond paying $5 every year had a presumptive worth of $100 and maturity of 25 years. The adjustment in the bond cost from $100 to $125 would likewise bring about a capital loss of $1 every year. The yield of the bond would drop from 5% to about 3%.