Answer to Question #203105 in Macroeconomics for Akhona Klanisi

Question

Assume the economy is in a recession. Explain how each of the following policies would affect consumption, investment and national income (GDP). In each case, indicate any direct effects, any effects resulting from changes in the macroeconomic variables and the overall effect in the economy. If there are conflicting effects making the answer ambiguous, say so.

A)     How monetary policy influences aggregate demand and how these can be used to expand the economy

Answer 1

During recession, expansionary monetary reduces interest rates shifting aggregate demand to the right and leading to the new equilibrium at point where there is a higher potential GDP level of output with a relatively small rise in the price level.

Banks use the expansionary monetary policy to stimulate the economy during recession by expanding monetary supply which in turn results in lower interest rates and borrowing costs consequently boosting consumption and investment.