Answer to Question #219908 in Macroeconomics for Vigilant

Question

Consider the dynamic AS-AD model and suppose that the economy starts
at the natural level of output.
(a) Discuss the short and medium run effects of a decrease in the money growth rate.
Make sure to describe the adjustment process.
(b) Now, suppose that you are asked to advice the monetary authorities on how to reduce
the inflation rate. You are faced with two options: a gradual reduction over several
years or an immediate reduction. What particular features of the economy would you
like to look at before giving your advice

Answer 1

a) decrease in money growth rate will reduce income and raise interest rates. Consumption will then fall due to the reduced income as well as an investment since the interest rises. To correct the decrease in money growth rate, the central bank has to make changes on interest rates to impact investment and aggregate demand.

b) the money supply and the interest rates.

 Reducing money supply raises the interest rates, thereby lowering the economy's demand, which lowers inflation.