(Monetary Policy and an Expansionary Gap) Suppose the Fed wishes to use monetary

Question

(Monetary Policy and an Expansionary Gap) Suppose the Fed wishes to use monetary policy to close an expansionary gap.
a. Should the Fed increase or decrease the money supply?
b. If the Fed uses open-market operations, should it buy or sell government securities?
c. 10. Determine whether each of the following increases, decreases, or remains unchanged in the short run: the market interest rate, the quantity of money demanded, investment spending, aggregate demand, potential output, the price level, and equilibrium real GDP

Explanation / Answer

Answer:

Expansionary Gap is the same as inflationary gap.

a) It must decrease the money supply so as to limit the circulation of money thereby fulfilling the gap.

b) It must buy government securities so that supply of money decreases.

c)

I) The market interest rate would decrease.
II) The quantity of money demanded would decrease.
III) Investment spending would decrease.
IV) Aggregate demand would decrease.
V) Potential output/GDP would remain as such in short-run.
VI) The price level would decrease as expansionary gap is to end.
VII) Equilibrium real GDP would remain above potential output.

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