Expansionary Monetary Policy Cause and Effect Chain Problem
Expansionary Monetary Policy Cause and Effect Chain Problem: Recession
Recessionary Gap AD/AS LRAS PL SRAS PLe AD Ye YF GDPr
Tools of Expansionary Monetary Policy and usage: 1. Reserve Requirement – decrease. (creates more excess reserves that may be loaned out & increases the Money Supply).
2. Discount Rate – Decrease. (makes it less expensive for banks to borrow money from the Fed. This increases excess reserves & increases the money supply)
3. Open Market Operations – Buy bonds. (this also increases the money supply, creating more excess reserves to lend out).
Does the Fed directly set the Federal Funds Rate? - no, it is the interest rate charged by banks when other banks borrow from them.
How does the Fed influence the Federal Funds Rate for Expansionary Monetary Policy (fighting recession)? - It buys government securities (mostly bonds), which increases the money supply. As such, banks have more excess reserves to lend and more money will be borrowed due to the lower interest rates. (Consumer and Business Investment borrowing increase).
Money Market i% MS MS 1 i i 1 MD Q 1 MS Q so i% Q
AD/AS LRAS PL SRAS PLe --------- PLf AD 1 Ye AD Yf GDPR Because the i% decreased due to the expansion of the Money Supply, C and IG spending (the interest sensitive parts of AD) increased as borrowing money became cheaper, Therefore, AD increases, GDPR increases, & PL increases, u% decreases, and, incomes increases.
Market for U. S. Dollar $ S e e 1 D 1 q D Q Demand for the $ declines because foreign investors dislike the lower i% in the U. S. and don’t want to purchase U. S. investments like govt securities. Therefore, the $ depreciates.
Net Export Effect of Expansionary Monetary Policy: 1. 2. 3. for 4. The U. S. $ Depreciated. U. S. Imports decrease as Americans have less buying power foreign products. U. S. Exports increase because American products are now cheaper foreigners. Therefore Xn (Exports minus Imports) goes up. 5. As such, AD/GDPr go up slightly, strengthening Expansionary Monetary Policy.
Contractionary Monetary Policy Cause and Effect Chain Problem: Inflation
Tools of Contractionary Monetary Policy and usage: 1. Reserve Requirement – increase. (creates fewer excess reserves that may be loaned out & decreases Money Supply).
2. Discount Rate – increase. (makes it more expensive for banks to borrow money from the Fed. This decreases excess reserves & decreases the money supply)
3. Open Market Operations – Sell bonds. (this also decreases the money supply, creating fewer excess reserves to lend out).
Does the Fed directly set the Federal Funds Rate? - no, it is the interest rate charged by banks when other banks borrow from them.
How does the Fed influence the Federal Funds Rate for Contractionary Monetary Policy (fighting inflation)? - It sells government securities (mostly bonds), which reduces the money supply. As such, banks have fewer excess reserves to lend and will only lend them out at higher interest rates.
Money Market i% MS 1 MS i 1 i MD Q 1 Q MS . : i%↑ Q
AD/AS LRAS PL SRAS PLe PLf AD YF AD 1 Ye GDPR Because the i% increased due to the contraction of the Money Supply, C and IG spending (the interest sensitive parts of AD) decreased as borrowing money became more expensive, Therefore, AD . : GDPR↓ & PL↓. : u%↑, incomes ↓.
Market for U. S. Dollar £/$ S e 1 e D q q 1 Q£ D 1 Demand for the $ because foreign investors like the higher i% in the U. S. and want to purchase U. S. investments like govt securities. Therefore, the $ appreciates relative to the £
Net Export Effect of Contractionary Monetary Policy: 1. 2. 3. 4. The U. S. $ Appreciated. U. S. Imports increase as Americans have more buying power foreign products. U. S. Exports decease because American products are now more expensive foreigners. Therefore Xn (Exports minus Imports) goes down. 5. As such, AD/GDPr go down slightly, strengthening Contractionary Monetary Policy.
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