After the 2008 \"great recession\" both the U.S. Federal Reserve and the Europea

Question

After the 2008 "great recession" both the U.S. Federal Reserve and the European Central Bank increased money supply in their respective area (The US. Federal Reserve increased the supply of U.S. dollars and the European Central Bank increased the supply of Euros.) Assume that each central bank increased its own area's money supply by exactly 10% What is the theoretical effect of the 10% increases in money supplies on each of the following? A. Interest rates in the two areas B. Price level in U.S. C. Long run real output in Europe D. The exchange rate between U.S. and Europe E. The balance of trade between U.S. and Europe Decrease)Increase No Effect

Explanation / Answer

A. As money supply rises, the LM curve shift rightwards and so interest rates will decline in both areas.

B. As money supply rises the AD curve will shift rightwards and so prices increases in the US.

C. As the money supply rises, the AD curve will shift rightwards in the short run, In the long run the economy moves back to the long run level. So long run real output is unchanged.

D. This will depend on the relative changes in interest rates between US and Europe. If interest rates in US rise faster than in Europe then the dollar will appreciate relative to the euro.

E. If the dollar appreciates with respect to the euro then the balance of trade in the US will worsen as the demand for US goods falls in Europe. The European balance of trade will improve. This depends on interest rates in the end.

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