Project #32962 - Macroeconomics

I believe it would be much better for learning if students assessed themselves on Stumper IV because we are so close to the final exam where knowledge is critical. So, instead of providing a grade like I normally do, I would like you to assess your own assignment against the answer key. For each of the questions a, b and c, please write complete paragraphs with several sentences that assesses your answer against the key's fully correct answer. Afterwards, please assign an overall grade for the assignment from 1 to 20. Learning like this may seem difficult but I believe self-assessment will work toward higher achievement.

 

Score my assignment with the key answers given complete with explanations

my answer:

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.

Answer:

The fed enacted an expansionary policy as the fed funds rate was going down. The Fed likely put money by buying bonds. Bonds are bought from the bond dealers. Supply of the fed funds rate increases as there is more deposit, which makes the excess reserves to occur more. Due to more loanable funds in the market, interest rate in market will fall. When interest rate falls, autonomous spending will increase. Therefore, expenditure multiplier will be enhanced. Banks are required to hold fewer reserves and can then make more loans. This in turn repeats the cycle of loan to deposit, resulting in a greater increase in the money supply. For a given initial deposit, a smaller reserve requirement will result in a larger money multiplier, and thus in a larger change in the money supply. So, when there is more money in the economy, the supply line shifts to the right and decreases the Fed funds rate from 4% to 2%.

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.

Answer:

If the economy is in a trough during the business cycle, the fed needs to expand the money supply because the economy is in a mild recession. Government usually responds to an economic recession through stimulative fiscal policy, expansionary monetary policy or a combination of the two. Stimulative fiscal policy involves higher government spending in an attempt to stimulate the economy. Expansionary monetary policy consists of actions by central banks, such as the U.S. Federal Reserve, to expand the money supply to encourage more consumer spending and business lending. In the short run, the fed would try to shift the customer's aggregate demand by decreasing the interest rates, lowering the reserve ratio, or purchase of government bonds.

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

Answer:

Supply curve of potential employee will shift backward because, the fed policy can cause an obstacle to come up from the labor market reaction. Employers must keep the good employees, so employees need to keep up with greater cost to live which is caused by inflation, salaries for employees will need to be raised.

The aggregate supply curve will shift backwards caused by a high salary and adjustment of labor market. If the shift crosses the potential line, the unemployment rate will be greater than the national rate. So in a long term case, then the new interest rates and money supply would become the new equilibrium - the supply and demand lines would shift to make these factors the new equilibrium in the economy.

The first new equilibrium point is reached by the aggregate demand curve, it will project a higher price, more output, lower unemployment rate, and occurrence of inflation. This process is called the short term equilibrium. We can see the aggregate supply curve that shifts backwards as the labor market shows the adjustment. There’s also the second new equilibrium point which the aggregate demand curve and the potential curve will intersect with the aggregate supply curve. In conclusion, we can say that at this point that price will be higher than before and the unemployment is at natural rate.

 

key answer :

a)The Fed implemented expansionary monetary policy. This is indicated by the fed funds rate falling from 4% to 2%. “In expansionary monetary policy, the Fed purchases a large amount of government bonds from securities dealers who have accounts with large banks…The Fed pays for the bonds with new reserves deposited in the bank accounts of the bond sellers. The supply of reserves increases relative to demand, and the fed funds rate falls…Banks, in turn, use a fraction of the additional reserves for loan making. More loans are accepted by reducing the interest rate charged to would-be borrowers. Interest rates in various loanable funds markets tend to follow the same direction determined by banks…When monetary policy is expansionary, the interest rate in the loanable funds market falls because the supply of loanable funds increases relative to demand." (Quotations from the eBook.)

 

b) It has been explained that the interest rate falls in the loanable funds market in the short-run. Financial intermediaries will make more loans.

As a result - autonomous spending increases in the short-run. This increase occurs potentially within three sectors that are sensitive to a lower interest rate. Business firms increase investment spending where some rates of return on capital projects prove to be viable at the lower cost of borrowing. Households increase borrowing and purchases of durable (consumption) goods. In addition, the lower interest rate causes the dollar to depreciate in the foreign exchange market. A lower valued dollar increases exports and decreases imports - net exports via the rest of the world increase. As a result - induced spending by households on consumption increases in the short-run as the income expenditure multiplier effect works in a positive direction. Increases in autonomous spending cause more income, which causes more consumption, etc. The total result from all the sectors is expansion in the business cycle. Real GDP will rise, and eventually the unemployment rate will fall. Demand pull inflation could begin if the economy started approaching capacity.

 

c)An increase in autonomous and induced spending can be illustrated by the aggregate demand curve shifting rightward against the aggregate supply curve. The new short-run equilibrium is seen at a higher level of output in the output market, but also at a higher price level as the economy nears capacity. If the policy continued as described for several years, output is likely to expand beyond long-run potential and demand-pull inflation will be significant.

As a result of the expansion beyond capacity - unemployment will temporarily fall below the natural rate of unemployment of about 5%. Persistent demand pull inflation will lead to a long-run adjustment in the labor market. Workers will realize that prices for output are rising, while firms will be inclined to pay higher wages in order to retain their workers. The cost of production rises. When wage increases cause production costs to rise, firms end-up producing at higher prices. This is indicated by a decrease in aggregate supply - the curve shifting leftward against the aggregate demand curve. As a result - another equilibrium is established. A decrease in output occurs simultaneously with an increase in the price level. The decrease in output indicates recession, while the increase in the price level indicates more inflation. The result, all together, is stagflation. For awhile, the economy could be below potential with a high unemployment rate accompanying high inflation. The economy eventually settles toward its long-run potential output in the output market, but has transitioned to a higher price level after the inflation. The potential output is the place where the economy tends to settle - the place dictated by resource capabilities, one indicator being the natural rate of unemployment at about 5%.

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Due By (Pacific Time) 06/10/2014 11:59 pm
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