Macroeconomics
Table 3: How Expansionary and Contractionary Monetary Policies Work Expansionary Monetary Policy to Close a Recessionary Gap (High Unemployment)
Contractionary Monetary Policy to Close an Inflationary Gap (High Inflation) OMO that consists of the Fed selling securities, or raising rr, or raising the discount rate ↓ Excess reserves decrease ↓ Federal funds rate increases ↓ Money supply decreases ↓ Interest rate increases ↓ Investment spending decreases ↓ Aggregate demand decreases ↓ Inflation (price level) decreases A contractionary monetary policy in a banking system with ample reserves would only raise IOR.
OMO that consists of the Fed buying securities, or lowering rr, or lowering the discount rate ↓ Excess reserves increase ↓ Federal funds rate decreases ↓ Money supply increases ↓ Interest rate falls ↓ Investment spending increases ↓ Aggregate demand increases ↓ Real GDP increases An expansionary monetary policy in a banking system with ample reserves would only reduce IOR.
Short-Run Efects of an Expansionary Monetary Policy An investment demand curve illustrates theinverserelationshipbetweentherealinterestrateand investment (investment spending in table 3). Similar to thedemandforloanablefundscurve, asreal interestratesdecrease ,thecostofborrowingtoinvestdecreases causinganincreaseinthedemand forinvestment . Ahigherrealinterestrate ,ontheotherhand,increasesthecostofborrowing causing a decrease in the demand for investment . Therefore, the demand for investment curve (D I ) is also downward sloping.
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