Project #32249 - Macroeconomics

a. Assume that fed funds rate was 4% but fell to 2% due to the monetary policy of the Fed. What type of monetary policy did the Fed enact?  Explain by describing supply and demand in the fed funds market and the money multiplier.

Decreasing Fed funds rate is an Expansionary Monetary Policy. When Fed buys bonds from bond dealer, demand deposit of the dealers increases, therefore reserves increases too. Supply of reserves increases relative to demand, so surplus of reserves (fed funds) happens, therefore fed funds rate decreases. There will be more money multiplier. Interest rate of loanable funds market will decreases, therefore more autonomous spending and induced spending.

b. If the economy were in a trough of the business cycle, what would you expect to happen to the economy in the short-run from the Fed's policy?  Explain in detail.

After trough, expansion will be expected to occur. When expansion happens, interest rate will fall, causing more investment spending, consumption and depreciation on the currency.  Exports went up, households becomes more wealthy and government purchases increase. Expectation of firms and households change and they will start to spend more. Autonomous spending will increase, which will induce more consumption spending, creates more income/expenditure multiplier. Aggregate demand curve shifts outwards, creating more output, therefore there will be less unemployment rate. But trade-off may occur because inflation rate went up too.

c.  If the Fed's policy continued for several years, what would you expect to eventually happen to the economy?  Explain while describing the shifts in aggregate supply and demand.

During an expansion, Aggregate demand curve will move outward and expand to meet the potential output. The aggregate demand curve might shifts outward too much, which cause output to expand over it's potential. A new short-term equilibrium is created. Unemployment rate fall as output rises but it has pulled inflation up so demand-pull inflation occurs. Wages rises as inflation occur because their wages should keep up with the rising prices. Higher wages increases costs of production, which shifts aggregate supply curve to left. Stagflation occurs. Higher price level is set and quantity demanded fall, so output decreases and unemployment rate increase.  The Aggregate supply curve will eventually settle where output is at it's potential, and there will be higher price level.

During a recession, the output will be over it's potential and it's aggregate demand curve will move inward to meet it's potential output. When the Aggregate demand curve keeps shifting to the left and it's output fall below the potential, it creates a new short-term equilibrium. Unemployment rate increases as output falls and price-level fall. Disinflation occurs because inflation rate decreases. Wage rate decreases, which decreases the cost of productions. So aggregate supply curve will shift to the right, increasing output. Disinflation will occur, inflation rate falls below 0%. Lower price is set and quantity demanded increase, increasing output and decreasing unemployment rate. The Aggregate supply curve will also eventually settle where output is at it's potential. And price level will fall.

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Due By (Pacific Time) 06/01/2014 11:59 pm
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