Question

5. Changes in the money supply 

The following diagram represents the money market in the United States. Suppose that the United States is a closed economy that does not interact with other economies in the world. The money market is currently in equilibrium at an interest rate of 5.50%, and the quantity of money in the economy is $1 trillion, as indicated by the grey star. 

Suppose the Fed announces that it is raising its target interest rate by 50 basis points, or 0.50%. To do this, the Fed will use open market operations to _______ the public in order to _______ the _______ money.

 Use the green line (triangle symbols) on the previous graph to illustrate the effects of this policy by placing the new money supply curve (MS) in the correct location. Place the black point (X symbol) at the new equilibrium interest rate and quantity of money.

 Suppose the following graph shows the aggregate demand curve for the U.S. economy. The Fed's policy of targeting a higher interest rate will _______ the cost of borrowing, causing investment spending to _______  and the quantity of output demanded to _______  at each aggregate price level. Shift the curve on the graph to show the general impact of the Fed's new interest rate target on aggregate demand.

Tool tip: Click and drag the curve. The curve will snap into position, so if you try to move the curve and it snaps back to its original position, just try the cost of borrowing, causing investment spending to and the quantity of output demanded to at again and drag it a little farther. 

Answer 1

New interest rate = 5.50+0.50 = 6%

Blanks:

1- Decrease

2- Supply of

3- Selling bonds to

4- Increase

5- Decrease

6- Decrease

When interest rate increases, the aggregate demand will decrease and the AD curve will shift to the left.