6. Monetary policy and the problem of inflationary and recessionary gaps Accordi

Question

6. Monetary policy and the problem of inflationary and recessionary gaps

According to the graph, the potential output of this economy is $16 trillion / $10 trillion / $8 trillion / $12 trillion / $20 trillion.

Since real GDP is currently $12 trillion (as shown by point A), this level of potential output means there is currently AN INFLATIONARY GAP / A RECESSIONARY GAP of $2 trillion / $4 trillion / $5 trillion / $1 trillion / $3 trillion.

On the previous graph, place the tan point (dash symbol) at the new long-run equilibrium output and price level if the Fed does not intervene. (Assume there are no feedback effects on the curve that does not shift.)

Now suppose the Fed chooses to intervene in an effort to move the economy more quickly back to its potential output. To do so, the Fed will INCREASE / DECREASE the money supply, which will DECREASE / INCREASE the interest rate, thereby giving firms an incentive to DECREASE / INCREASE investment, shifting the AD / SRAS / LRAS curve to the RIGHT / LEFT.

On the previous graph, place the black point (plus symbol) at the new long-run equilibrium output and price level if the Fed intervenes in this way and successfully brings the economy back to long-run equilibrium. (Again, assume there are no feedback effects on the curve that does not shift.)

Compare your answers from the previous few questions. If the Fed does not intervene, the economy will likely have relatively high UNEMPLOYMENT / INFLATION. On the other hand, if the Fed does intervene, it risks causing relatively high UNEMPLOYMENT / INFLATION, if it changes the money supply too much.

------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Below is a different version with explanations:

Explanation / Answer

Potential output is 16 trillions because of LRAS

As the current output is 20 trillions there is inflationary gap of 4 trillions.

So the fed will decrease the money supply and interest rate will increase and firm will invest less shifting AD curve to left.

Inflation, unemployment

Related Questions

Navigate

• Browse (All)
• Browse 6
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.