Question

Time Running: Attempt due: Feb 1 a 58 Minutes, 37 S MS1 MS2 MID Qi Q2 Q. Quantity

Answer 1

(a) This is the case of Reduction in Money supply. Hence, option (b) is correct. Also, y axis measures nominal interest rates, which have increased (4th, 8th options are correct). Also, increase in Interest rates will reduce the level of investment (5th statement). If discount rates or any such interest rates are increased, money supply decreases, hence this is correct too (3rd option)
If bonds are purchased by central banks, money supply increases, which is not the case here. This policy won't be followed during a recession, as it will further lead to decrease in Output and cause deflation.

(b) (i) At point A, economy below Long Run Aggregate Supply level, hence excess Capacity, GDP lesser than potential GDP. This would lead to some form of Deflation, also there would be Unemployment in the economy too.

(ii) Increasing Money supply here could be helpful, as it will lead to increase in inflation and price level, which would lead to an increase in Output. Also, due to difference in price expectations, the hiring would grow, reducing unemployment. The idea is to increase the level of Aggregate Demand, which is primarily done via Fiscal Policies, but fed reserve could only increase Money supply here to shift AD curve to reach a point on LRAS curve.

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