Chapter 21

Using the line drawing tool​, show the effect of increased government spending on the aggregate demand curve. Label your new line ​'AD2​'.

#24 Screenshot CH21

If the Fed lowers the money supply at the same time that government spending​ increases, how would this change your answer​ above?

#24 Screenshot CH21 The lower money supply would cause the aggregate demand curve to shift​ leftward, removing some or all of the effect of the increase in government spending.

An MP curve and an IS curve are shown above. Using the multipoint curved line drawing​ tool, draw three points on the AD curve when interest rates equal​ 1.5%, 2.0%, and​ 2.5%. Label the line​ 'AD'. Carefully follow the instructions​ above, and only draw the required object.

#26 Screenshot CH21

Suppose the monetary policy curve is given by r=2+0.5π​, and the IS curve is Y=14−r. Find the expression for the aggregate demand curve. The aggregate demand curve is Y= ___________

#27 Screenshot CH21

Assume that the inflation rate is held constant at pi Superscript starπ*. Using the line drawing tool​, show the effect of a decrease in financial frictionsa decrease in financial frictions on the following graphs. Properly label any lines that you draw. ​1.) The IS Curve

#37 Screenshot CH21

Why is it necessary for the MP curve to have an upward​ slope?

An​ upward-sloping MP curve keeps inflation from spinning out of control.

Describe how​ (if at​ all) the IS​ curve, MP​ curve, and AD curve are affected in the following ​situation: There is a decrease in autonomous consumption.

B. The IS and AD curves shift to the left comma and the MP curve does not shift. nbspThe IS and AD curves shift to the left, and the MP curve does not shift.

What is the key assumption underlying the​ Fed's ability to control the real interest​ rate?

Because inflation is relatively sticky in the short​ run, when the Federal Reserve changes the federal funds​ rate, it implies similar changes in real interest rates.

​"Autonomous monetary policy is more effective at changing output when λ is​ higher." Is this statement​ true, false, or​ uncertain? Explain your answer.

False. For a given IS​ curve, any change in autonomous monetary policy will have the same impact on output.

Which of the following causes the MP curve to shift​ down?

an autonomous easing of monetary policy

The Taylor principle

holds when λ>0.

A movement to the right along a given MP curve means

inflation is increasing.

If net exports were not sensitive to changes in the real interest​ rate, would monetary policy be more or less effective in changing​ output? Monetary policy would be ____ effective in changing output because net​ exports:

less C. represent an additional channel through which interest rate changes can affect output.

Which of the following factors will affect the slope of the aggregate demand​ curve?

mpc

The Federal Reserve can control real​ short-term interest rates because

prices are sticky.

When the Fed provides more reserves to the banking​ system, the money banks have to lend to each other ______ ​, and the federal fund rate ______

rises; falls

When r decreases​, this causes a movement along​ the________ curve, and shifts the ​_________ curve.

​IS; AD

Any factor that shifts the​ __________ curve shifts the​ __________ curve in the​ __________ direction.

​IS; AD; same

Why does the aggregate demand curve slope​ downward?

A rise in inflation works through the increase in real interest rates to reduce the equilibrium quantity of aggregate output.

Which of the following represents a movement along a given AD​ curve?

Inflation​ decreases, the real interest rate​ decreases, and aggregate output increases.

What is the monetary policy​ curve?

It indicates the relationship between the inflation rate and the real interest rate.

When r increases​, this causes a movement along​ the________ curve, and shifts the ​_________ curve.

IS; AD

When the inflation rate​ increases, what happens to the fed funds​ rate? Operationally, how does the Fed adjust the fed funds​ rate?

The Fed adjusts the fed funds rate up through open market sales of bonds.

How do changes in planned expenditures affect the aggregate demand​ curve?

The aggregate demand curve shifts to the right if autonomous​ consumption, autonomous​ investment, autonomous net​ exports, or government purchases​ increase, or if taxes decrease.

What is the real interest​ rate?

The nominal interest rate minus expected inflation.

If λ= 0, what does that imply about the relationship between the nominal interest rate and the inflation​ rate? When λ= 0,​this means that as inflation​ increases, the nominal interest rate will _______ by ________ the inflation​ rate, so that the real interest rate ________

increase; exactly the same; stays constant

The MP curve gives the relationship between the

real interest rate and the inflation rate.

Assume that the inflation rate is held constant at pi Superscript starπ*. Using the line drawing tool​, show the effect of an autonomous monetary policy tighteningan autonomous monetary policy tightening on the following graphs. Properly label any lines that you draw. ​1.) The IS Curve

#37Part 2 Screenshot CH21

Why does the monetary policy curve slope​ upward? ​(Check all that​ apply.)

A. When inflation​ increases, the supply of real money balances declines. This increases the equilibrium nominal interest rate in the money​ market, which also increases the real interest rate in the short run. C. Monetary policymakers will follow the Taylor principle and respond aggressively to an increase in the inflation rate by raising nominal interest rates by an even greater amount so that the real interest rate also rises.

Describe how​ (if at​ all) the IS​ curve, MP​ curve, and AD curve are affected in the following ​situation: There is an increase in the current inflation rate

D. There is a movement along the MP curve comma which increases the real interest rate comma a movement along the IS curveThere is a movement along the MP curve, which increases the real interest rate, a movement along the IS curve to lower output comma and a movement along the AD curve comma reducing output.

​"The Fed decreased the fed funds rate in late​ 2007, even though inflation was increasing. This demonstrates a violation of the Taylor​ principle." Is this statement​ true, false, or​ uncertain? Explain your answer.

False. It was the autonomous component of the fed funds rate that was decreased through an autonomous monetary policy easing. The​ Fed's distaste for inflation did not change and remained positive.

"If f ​increases, then the Fed can keep output constant by reducing the real interest rate by the same amount as the increase in financial​ frictions." Is this statement​ true, false, or​ uncertain? Explain your answer.

False. The Fed would need to reduce the real interest rate by a little bit less than the change in f to keep output constant

Why can the Fed control the real interest rate in the short run but not in the long​ run?

It adjusts for​ inflation, and prices are sticky in the short run.​ Hence, when a change in the​ Fed's monetary policy causes the nominal interest rate to​ change, the real interest rate also changes in the same direction. In the long​ run, actual and expected inflation change in response to changes in monetary​ policy, leaving the real interest rate unaffected.

What is the aggregate demand​ curve?

It is the relationship between the inflation rate and aggregate output when the goods market is in equilibrium.

If government spending increases while taxes are raised to balance the​ budget, which of the following is​ true?

One component of aggregate demand will increase and another will decrease.

If the central bank changes the autonomous real interest rate to r=3​, what will happen to output if inflation remains constant at​ 1%?

Output will decrease from Y=15 to Y=13. Since π=1​, then r=2+0.5π=2.5 and the orginal Y is given by Y=20−2r=20−2(2.5)=15. with r=3​, the new r equals r=r+λπ=3+0.5×1=3.5 and the new output will be given by Y=20−2r=20−2×3.5=13.

​__________ prices in the short run allow the Federal Reserve to control the real interest rate.

Sticky

Assume the IS curve is given as Y=14−2r​, and the MP curve is given as r=0.75+0.5π.

The AD curve is Y=14−2×0.75−π Y=12.50−π $34 Screenshot CH21

Assume that the IS curve is given as Y=20−2r and the MP curve is r=2+0.5π. Which of the following statements is​ true?

The AD curve is given as Y=16−π. The AD curve is given as Y=20−2×(2+0.5π)=16−π.

What would be the effect on the aggregate demand​ curve?

The AD curve will shift to the right.

Suppose that taxes are decreased and the central bank conducts an autonomous easing of monetary policy. What will be the​ result?

The IS curve shifts​ right, the MP curve shifts​ down, and the AD curve shifts right.

Suppose that a new Fed chair is​ appointed, and his or her approach to monetary policy can be summarized by the following​ statement: "I care only about increasing​ employment; inflation has been at very low levels for quite some​ time; my priority is to ease monetary policy to promote​ employment."

The MP curve will shift downward because decreasing unemployment results in a loosening of monetary policy.

What would be the effect of a decrease in U.S. net exports on the aggregate demand​ curve?

The aggregate demand curve shifts to the left.

What would be the effect of an increase in U.S. net exports on the aggregate demand​ curve?

The aggregate demand curve shifts to the right

How does a tightening or easing of monetary policy by the Fed affect the aggregate demand​ curve?

Tightening of monetary policy shifts the aggregate demand curve to the​ left, while easing of monetary policy shifts the aggregate demand curve to the right.

How does an autonomous tightening or easing of monetary policy by the Fed affect the MP​ curve?

When the Fed decides to raise the real interest rate at any given inflation​ rate, the MP curve shifts upward. Monetary policy​ easing, a decision to lower the real interest rate at any given inflation​ rate, shifts the MP curve downward.

How is an autonomous tightening or easing of monetary policy different than a change in the real interest rate due to a change in the current inflation​ rate?

With a tightening or easing of monetary​ policy, some projected changes in monetary policy independent of the current inflation rate may occur.

When the Fed drains reserves from the banking​ system, the money banks have to lend to each other ______ ​, and the federal fund rate ______

falls; rises

The Federal Reserve affects the​ short-term nominal interest rate

through adjusting reserves in the banking system.

The MP curve is _______ sloping due to the Taylor principle.

upward

Would a decrease in net exports affect the monetary policy​ curve?

​No, the monetary policy curve does not shift.

Would an increase in net exports affect the monetary policy​ curve?

​No, the monetary policy curve does not shift.