Question

6. (Problem 6) An economy is facing the inflationary gap shown in the accompanying diagram. Aggregate price level LRAS SRAS Real GDP Potential —YpY output To eliminate the gap, should the central bank use expansionary or contractionary monetary policy? How will the interest rate, investment spending, consumer spending, real GDP, and the aggregate price level change as monetary policy closes the inflationary gap? The central bank can use contractionary monetary policy. The interest rate will rise, which would encourage a decrease in investment spending and consumer spending. Real GDP will be fall and the aggregate price level will rise. O The central bank can use contractionary monetary policy. The interest rate will rise, which would encourage a decrease in investment spending and consumer spending. Real GDP and the aggregate price level will both fall. O The central bank can use expansionary monetary policy. The interest rate will decrease, which would encourage an increase in investment spending and consumer spending. Real GDP and the aggregate price level will both rise. The central bank can use contractionary monetary policy. The interest rate will rise, which would encourage a decrease in investment spending and consumer spending. Real GDP will rise and the aggregate price level will fall. Suppose that the Federal Reserve is conducting an expansionary monetary policy. It will Treasury bills on the open market, so that the money supply will , interest rates will planned investment spending will , and the AD curve will shift to the sell; increase; rise, rise; left O sell; decrease; rise; fall; left O buy; increase; fall; rise; right O buy; decrease; fall; fall; left monetary policy to interest rates, which 8. To fight a recession, the Federal Reserve should conduct_ will shift the aggregate demand curve to the expansionary; lower; left contractionary; lower; right expansionary; lower; right O contractionary; raise; left

Answer 1

6) the central bank can use contractionary monetary policy. The interest rate will rise, which would encourage a decrease in investment spending and consumer spending. Real GDP and aggregate price level will both fall (left shift of AD curve).

7) It will buy treasury bills on the open market, so that the money supply will increase, interest rates will fall, planned investment spending will rise, and the AD curve will shift to the right.

8) the Federal Reserve should conduct expansionary monetary policy to lower interest rates, which will shift the aggregate demand curve to the right.