Question

Suppose that the US Federal Reserve Board was able to confirm that the US economy is in the brink of a recession, operating at a GDP level (Y1) that is well below its full-employment capacity (YF). Your tasks are: a. Name one monetary policy, and specify the policy tool to use, that the Fed could make to help boost the economy. b. Using the AD-AS theory, show and EXPLAIN the expected short run and long run effect of this policy on the US economy.

Answer 1

Answer:

a.) To combat recession the federal reserve board can adopt expansionary monetary policy. The fed can reduce the cash reserve ratio.

b.) The aggregate output and price is going to increase in short run. In the long run though economy will be operating at equilibrium level.

Explanation:

With the decline in the cash reserve ratio the total reserves with the banks will increase. This will boost credit credit creation. As the money supply in the economy increases the aggregate demand will increase. This will further lead to increase in price and output level.

In the medium term, the aggregate supply will also increase though not as much as demand, so there will be excess of demand. The price level will rise further.

In the long run though output will always be at the equilibrium level.