The following graph represents the money market in a hypothetical economy. As in the United States, this economy has a central bank called the Fed, but unlike in the United States, the economy is closed (that is, the economy does not interact with other economies in the world). The money market is currently in equilibrium at an interest rate of 5% and a quantity of money equal to $0.4 trillion, as indicated by the grey star.
The following graph represents the money market in a hypothetical economy. As in the United States, this economy has a central bank called the Fed, but unlike in the United States, the economy is closed (that is, the economy does not interact with other economies in the world). The money market is currently in equilibrium at an interest rate of 5% and a quantity of money equal to $0.4 trillion, as indicated by the grey star.
Chapter16: Monetary Policy
Section: Chapter Questions
Problem 8SQ
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Transcribed Image Text:The following graph represents the money market in a hypothetical economy. As in the United
States, this economy has a central bank called the Fed, but unlike in the United States, the
economy is closed (that is, the economy does not interact with other economies in the world). The
money market is currently in equilibrium at an interest rate of 5% and a quantity of money equal to
$0.4 trillion, as indicated by the grey star.
Shift the curve on the graph to show the general impact of the Fed's new interest rate tarç
aggregate demand.
7.0
6.5 +
New MS Curve
Money Demand
6.0
5.5
New Equilibrium
5.0
Aggregate Demand
4.5
4.0
3.5
Money Supply
3.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
MONEY (Trillions of dollars)
Aggregate Demand
Suppose the Fed announces that it is lowering its target interest rate by 25 basis points, or 0.25
percentage point. To do this, the Fed will use open-market operations to
the
money by
v the public.
OUTPUT
Use the green line (triangle symbol) on the previous graph to illustrate the effects of this policy by
placing the new money supply curve (MS) in the correct location. Place the black point (plus
symbol) at the new equilibrium interest rate and quantity of money.
Suppose the following graph shows the aggregate demand curve for this economy. The Fed's policy
of targeting a lower interest rate will
business investment spending to
- the cost of borrowing, causing residential and
and the quantity of output demanded to
at
each price level.
INTEREST RATE (Percent)
PRICE LEVEL
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