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Chapter 16: Q.2 - Problems (page 373)

Suppose that each 0.1percentage point increase in the equilibrium interest rate induces a \(5billion decrease in real planned investment spending by businesses. In addition, the investment multiplier is equal to 4, and the money multiplier is equal to 3. Furthermore, every \)9billion decrease in money supply brings about 0.1-percentage-point increase in the equilibrium interest rate. Use this information to answer the following questions under the assumption that all other things are equal.

a. How much must real planned investment decrease if the Federal Reserve desires to bring about an $80billion decrease in equilibrium real GDP ?

b. How much must the money supply change for the Fed to induce the change in real planned investment calculated in part (a)?

c. What dollar amount of open market operations must the Fed undertake to bring about the money supply change calculated in part (b) ?

Short Answer

Expert verified

Change in investment needed = $20billion

Change in money supply needed = $36billion

Amount of open market operations, bonds sold = $12billion

Step by step solution

01

Investment Multiplier Concept

Investment multiplier shows multiple times increase in income due to change in income.

Formula = Change in Income/ Change in Investment

As multiplier = 4, desired change in income = -80

So, 4= -80/ Change in investment

Hence, change in investment needed = -80/4=$20billion

02

Money Supply, Interest Rate & Investment Elasticity

As 0.1%decrease in equilibrium interest rate leads to $5billion increase in real planned investment. So, 0.4% decrease in interest rate will lead to required $20billion dollars decrease in investment

As 0.1%change in interest rate is led by $9billion increase in money supply. So, decrease in interest rates needed can be achieved by $36billion decrease in money supply.

03

Money Multiplier Concept

Money multiplier shows the multiple times increase in money supply due to change in government monetary policy (FOMC selling bonds here).

Money Multiplier = Money supply change / Monetary policy change (bonds' sale)

As money multiplier = 3, needed money supply change = 36billion

So, 3=36/ Monetary policy open market operations amount

Monetary policy OMO amount = 36/3

Monetary policy open market bonds' purchase = $12billion

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Most popular questions from this chapter

Understand the equation of exchange and its importance in the quantity theory of money and prices.

Take a look at Figure 16-3. Discuss a policy action that the Trading Desk at Federal Reserve Bank of New York could undertake in order to bring about the increase in aggregate demand displayed in the figure

Assuming that the Fed judges inflation to be the most significant problem in the economy and that it wishes to employ all of its policy instruments except interest on reserves, what should the Fed do with its policy tools?

Assume that the following conditions exist :

a. All banks are fully loaned up - there are no excess reserves, and desired excess reserves are always zero.

b. The money multiplier is 4.

c. The planned investment schedule is such that at a 4percent rate of interest, investment is \(1400billion. At 5percent, investment is \)1380billion.

d. The investment multiplier is 5.

e. The initial equilibrium level of real GDP is \(19trillion.

f. The equilibrium rate of interest is 4percent.

Now the Fed engages in contractionary monetary policy. It sells \)2billion worth of bonds, which reduces the money supply, which in turn raises the market rate of interest by 1 percentage point. Determine how much the money supply must have decreased, and then trace out numerical consequences of the associated increase in interest rates on all other variables mentioned.

Suppose that, initially, the U.S. economy was in an aggregate demand-aggregate supply equilibrium at point A along with the aggregate demand curve AD in the diagram below. Now, however, the value of the U.S. dollar suddenly appreciates relative to foreign currencies. This appreciation happens to have no measurable effects on either the short-run or the long-run aggregate supply curve in the United States. It does, however, influence U.S. aggregate demand.

a. Explain in your own words how the dollar appreciation will affect net export expenditures in the United States.

b. Of the alternative aggregate demand curves depicted in the figure- AD1versus AD2which could represent the aggregate demand effect of the U.S. dollar's appreciation? What effects does the appreciation have on real GDP and the price level?

c. What policy action might the Federal Reserve take to prevent the dollar's appreciation from affecting equilibrium real GDP in the short run?
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