If the public is willing to hold whatever amount of money supplied at a given interest rate, then an open market purchase by the central bank will 1. Lower the rate of interest and increase the level of income 2. Raise the interest and lower the level of income 3. Not affect the rate of interest or level of income 4. Lower the rate of interest and lower the level of income
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An open market purchase involves the central bank buying government securities from commercial banks and other financial institutions. This action increases the money supply in the economy. Show more…
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Suppose the Fed announces that it is raising its target interest rate by 75 basis points, or 0.75 percentage points. To do this, the Fed will use open-market operations to the money by the public. Suppose the following graph shows the aggregate demand curve for this economy. The Fed's policy of targeting a higher interest rate will the cost of borrowing, causing residential and business investment spending to and the quantity of output demanded to at each price level. 3. Changes in the money supply 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. However, 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 3% and a quantity of money equal to $0.4 trillion, as indicated by the grey star. Money Demand New MS Curve New Equilibrium Money Supply 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. Shift the curve on the graph to show the general impact of the Fed's new interest rate target on aggregate demand. Aggregate Demand PRICE LEVEL OUTPUT
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11. Congress and the president raise income taxes while at the same time the Fed increases the money supply. The initial equilibrium in the money market, prior to any such policy change, occurs where the vertical money supply curve intersects the downward-sloping money demand curve. A possible impact of higher taxes is that it causes the (1) curve to shift (2). A possible impact of the expansionary monetary policy is that it causes the (3) curve to shift (4). (1) money demand money supply (2) to the left to the right (3) money demand money supply (4) to the right to the left 12. Contractionary policies are designed to slow the economy and reduce inflation by decreasing aggregate demand and aggregate output. Contractionary fiscal policy and contractionary monetary policy have opposite effects on the interest rate despite having the same goal of decreasing aggregate output because contractionary monetary policy (1) the interest rate, whereas contractionary fiscal policy (2) the demand for money and the interest rate. 1.) Using the line drawing tool, draw a new line on the graph that shows the effect of contractionary monetary policy. Properly label your line. 2.) Using the point drawing tool, plot and label the new equilibrium interest rate. Note: Carefully follow the instructions above and only draw the required objects. (1) increases decreases (2) decreases increases 13. On June 5, 2003, the European Central Bank acted to decrease the short-term interest rate by half a percentage point to 2 percent. The bank's president at the time, Willem Duisenberg, suggested that the bank could reduce rates further in the future. The likely impacts of such a rate cut were A. an increase in planned aggregate expenditure, an increase in consumption, and an ambiguous effect on aggregate income and output. B. a decrease in planned aggregate expenditure, an increase in consumption, and a decrease in aggregate income and output. C. an increase in planned aggregate expenditure, an increase in aggregate income and output, and an increase in consumption. D. an increase in planned aggregate expenditure, an increase in aggregate income and output, but an ambiguous effect on consumption.
An important way in which the Federal Reserve decreases the money supply is by selling bonds to the public. Using a supply and demand analysis for bonds, show what effect this action has on interest rates. Is your answer consistent with what you would expect to find with the liquidity preference framework?
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