Let us consider the country of Wolverinistan, which starts off in a long-run equ

Question

Let us consider the country of Wolverinistan, which starts off in a long-run equilibrium. ecently two things have happened in this country: (1) the central bank decides to pursue a more expansionary monetary policy, and (2) citizens of the country, feeling good about their economic prospects, begin saving less and consuming more of their income. (a) (2 pt) What open-market operation would the central bank use to undertake this expansionary policy? (b) (3 pts) What will happen to the IS curve for this economy? Why?

Explanation / Answer

(a) A central bank will use an open market purchase of government securities as an expansionary monetary policy tool.

(b) Since citizens are saving less, economy's saving will decrease, and as a result the IS curve will shift toward left. Real interest rate will fall and output will fall as a result.

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