Macroeconomics

‭D‬ ‭LF‬ ‭decreases, S‬ ‭LF‬ ‭increases‬

‭r.i.r ↓‬

‭Q‬ ‭LF‬ ‭↕‬ ‭(indeterminate)‬

‭Indeterminate because‬ ‭change in Q‬ ‭LF‬ ‭is‬ ‭indeterminate‬

‭D‬ ‭LF‬ ‭decreases, S‬ ‭LF‬ ‭decreases‬

‭r.i.r ↕‬ ‭(indeterminate)‬

‭Q‬ ‭LF‬ ‭↓‬

‭Indeterminate because‬ ‭change in r.i.r is‬ ‭indeterminate‬

‭J. Central Bank and Control of the Money Supply‬ ‭In‬ ‭most‬ ‭economies,‬ ‭central‬ ‭banks‬ ‭play‬ ‭a‬ ‭crucial‬ ‭role‬ ‭in‬ ‭achieving‬ ‭key‬ ‭macroeconomic‬ ‭objectives,‬ ‭primarily‬ ‭centered‬ ‭on‬ ‭maintaining‬ ‭price‬ ‭stability‬ ‭(i.e.,‬ ‭controlling‬ ‭inflation)‬ ‭and‬ ‭ensuring‬ ‭full‬ ‭employment‬‭by‬‭minimizing‬‭output‬‭gaps‬ ‭.‬‭Central‬‭banks‬‭or‬‭the‬‭Fed‬‭in‬‭the‬‭U.S.‬‭accomplish‬‭this‬‭through‬ ‭monetary‬‭policy‬ ‭,‬‭which‬ ‭uses‬‭the‬‭money‬‭supply‬‭to‬‭impact‬‭macroeconomic‬‭indicators‬‭such‬‭as‬‭output,‬ ‭inflation,‬ ‭and‬ ‭unemployment‬ ‭.‬ ‭The‬ ‭Fed‬ ‭uses‬ ‭monetary‬ ‭policy‬ ‭to‬ ‭influence‬ ‭economic‬ ‭activity‬ ‭by‬ ‭adjusting‬‭the‬‭money‬‭supply‬‭and,‬‭consequently,‬‭interest‬‭rates‬ ‭,‬‭with‬‭the‬‭goal‬‭of‬‭controlling‬‭spending‬‭in‬ ‭the economy. A change in money supply creates the following chain of effects:‬

‭Recap of Expansionary and Contractionary Monetary Policies‬ ‭An‬ ‭expansionary‬ ‭monetary‬ ‭policy‬ ‭is‬ ‭implemented‬ ‭by‬ ‭a‬ ‭central‬ ‭bank‬ ‭with‬ ‭the‬ ‭aim‬ ‭of‬ ‭increasing‬ ‭aggregate‬ ‭demand‬ ‭(AD)‬ ‭and‬ ‭output‬ ‭and‬ ‭reducing‬ ‭unemployment‬ ‭.‬ ‭This‬ ‭is‬ ‭implemented‬ ‭in‬ ‭times‬ ‭of‬ ‭recession‬‭and‬‭economic‬‭downturn‬‭in‬‭order‬‭to‬‭close‬‭negative‬‭output‬‭gaps.‬ ‭For‬‭more‬‭information‬‭on‬‭output‬ ‭gaps, please refer to Chapter 3 Section E.‬ ‭An‬ ‭expansionary‬ ‭monetary‬ ‭policy‬ ‭involves‬ ‭increasing‬ ‭the‬ ‭money‬ ‭supply‬ ‭to‬ ‭lower‬ ‭interest‬ ‭rates‬ ‭.‬ ‭Lower‬ ‭interest‬ ‭rates‬ ‭encourage‬ ‭borrowing‬ ‭and‬ ‭investment,‬ ‭leading‬ ‭to‬ ‭higher‬ ‭aggregate‬ ‭demand‬ ‭(AD)‬ ‭and, ultimately, increased output.‬ ‭Alternatively,‬ ‭a‬ ‭contractionary‬ ‭or‬ ‭restrictive‬ ‭monetary‬ ‭policy‬ ‭is‬‭implemented‬‭by‬‭a‬‭central‬‭bank‬ ‭with‬ ‭the‬ ‭aim‬ ‭of‬ ‭reducing‬ ‭AD‬ ‭in‬ ‭order‬ ‭to‬ ‭decrease‬ ‭inflation‬ ‭.‬ ‭This‬ ‭is‬ ‭implemented‬ ‭in‬ ‭times‬ ‭of‬ ‭booms‬ ‭associated with high price levels in order to close positive output gaps.‬ ‭A‬‭contractionary‬‭monetary‬‭policy‬‭involves‬‭reducing‬‭the‬‭money‬‭supply‬‭to‬‭raise‬‭interest‬‭rates‬ ‭.‬‭Higher‬ ‭interest‬ ‭rates‬ ‭discourage‬ ‭borrowing‬ ‭and‬ ‭investment,‬ ‭leading‬ ‭to‬ ‭lower‬ ‭AD,‬ ‭and‬ ‭ultimately,‬ ‭lower‬ ‭price‬ ‭levels.‬

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