4. Quiz
1. What are the four tools the
central bank can use to manage
the money supply.
2. If you want to increase the
money supply, how would you
use each of the four tools?
14. Problem
Recession
Shift AD to
Right
In๏ฌation
Shift AD to Left
Tools
Increase
Money Supply
Decrease
Money Supply
Reserve Ratio Lower Raise
Discount Rate Lower Raise
Open Market
Operations
Buy Bonds
from the Banks
Sell Bonds
to the Banks
Excess Reserves
Interest Rate
Lower Raise
15. Illiquid
No cash
Net worth to pay debt, but canโt
sell quick and without loss
Insolvent
No cash
No net worth to pay debt
20. The graph below shows the US economy in long run equilibrium
with a spending growth of 13 percent, a 9 percent in๏ฌation rate, and
a 4 percent real GDP growth.ย
Step 1: Suppose that to reduce in๏ฌation the Fed permanently
decreased money supply growth by 5 percent. Using the copy tool,
show the short run effect this would have by shifting and labeling
the appropriate curve(s). Plot the new short run equilibrium using
the double drop line tool and label it Equilibrium 2.ย
Step 2: Show how the economy will adjust in the long run by shifting
and labeling the appropriate curve(s). Plot the new long run
equilibrium and label it Equilibrium 3.ย
Total Spending Rate = In๏ฌation Rate + Real GDP Growth Rate
13% = 9% + 4%
8% = 4% + 4%
21. 0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Real GDP Growth Rate
In๏ฌation
Rate
Total Spending = In๏ฌation Rate + Real GDP Growth Rate
13% = 9% + 4%
Reduce Money Growth Rate by 5%
Reduces In๏ฌation Rate from 9% to 4%
8% = 4% + 4%
Short Run 8% = 7% + 1%
T.S. = 13%
T.S. = 8%
Long Run 8% = 4% + 4%
RecessionGrowth
22. Because prices are sticky going
down, you cannot reduce in๏ฌation
without having a temporary
recession
As the price level falls, spending
increases back to capacity
24. The graph below shows the US economy in long run
equilibrium with a spending growth of 13 percent, a 9 percent
in๏ฌation rate, and a 4 percent real GDP growth.ย
Total Spending = 13%
25. Step 1: Suppose that to reduce in๏ฌation the Fed permanently
decreased money supply growth by 5 percent. Using the copy tool,
show the short run effect this would have by shifting and labeling the
appropriate curve(s). Plot the new short run equilibrium using the
double drop line tool and label it Equilibrium 2.ย
In๏ฌation 9% to 4%
Push Down by 5%
1
2
26. Step 2: Show how the economy will adjust in the long run by
shifting and labeling the appropriate curve(s). Plot the new
long run equilibrium and label it Equilibrium 3.ย
In๏ฌation 9% to 4%
1
2
3
2
27. Suppose the Fed permanently increases money supply
growth by 3 percent. Using the copy tool, show the short run
effect this would have by shifting and labeling the appropriate
curve(s). Plot the new short run equilibrium using the double
drop line tool and label it Equilibrium 2.ย .ย
1
3
2
