Question

The real work is done by three traders who are referred to during the operation as trader one, trader two, and trader three. On one recent morning, trader one was Tiffany Wilding, 26. While she reviewed the stream of offers and then the prices finally accepted by the algorithm, trader two, Blake Gwinn, 29, double-checked her decisions and trader three, James White, 29, made a duplicate of everything in case the computers crashed. All the while, Mr. Frost stood behind his colleagues, ready to intervene — and even cancel the Federal Reserve’s purchases — at any sign of trouble. Source: NYT.

Refer to Article Summary 3.

All else equal, what will happen to the short-run equilibrium price level and real GDP in the USA? Explain and show graphically the effect of this change in monetary policy in an AD-AS diagram.

Answer 1

The monetary policy tool that is referred to is open market purchase of securities, which will increase money supply, thus lowering interest rate. Investment will rise as a result, increasing aggregate demand and shifting AD curve to right, increasing both price level and real GDP.

In following graph, initial equilibrium is at point A where AD0 (aggregate demand) and SRAS0 (short-run aggregate supply) curves intersect, with initial equilibrium price level P0 and initial equilibrium real GDP Y0. When investment increases, AD curve will shift right from AD0 to AD1, intersecting SRAS0 at point B with higher price level P1 and higher real GDP Y1.

SRASO B A Po ADI ADo Yo