Question

Question 2 : A Model with a Different Monetary Policy Rule


(a) (10 points) Combine the AS/AD and Monetary Policy equations so that you can plot

them on a c1, 1 graph. What is the impact of introducing c on the relative slopes of the

AS/AD lines?

(b)

Answer 1

Stimulating monetary policy is carried out during a recession, with the aim of

“Invigorating” the economy, stimulating the growth of business activity (stimulation

AD) and is used as a means of combating unemployment. Stimulating

monetary policy is to implement measures by the Central Bank to increase

money offers:

• decrease in reserve requirements

• lower refinancing rate

• purchase by the Central Bank of government securities from firms and households

Restraining monetary policy is carried out during the boom, “overheating”

economy, aimed at reducing business activity (containment AD) and

regarded as a means of combating inflation. Restraining Monetary Policy

consists in the use by the Central Bank of measures to reduce the supply of money:

• increase in reserve requirements

• increase in the refinancing rate

• sale by the Central Bank of government securities.

1) 2)

1)Stimulating monetary policy: AD shifts to the right AD₁ to AD₂, prices are rising and output is rising

2)Restraining monetary policy: AD moves to the left AD₂ to AD₁, prices are falling and output is falling