Answer to Question #286399 in Macroeconomics for Danielle

Question

Assuming the economy was in a recession which was taken care of by the monetary sector through monetary expansion. Consider the short and long run effects of the policy on output, employment, interest rate and price level.

Answer 1

Most economists agree that, in the long run, output—as measured by GDP—is stable, therefore changes in the money supply only affect prices. However, because prices and wages do not normally adapt promptly, changes in the money supply might affect actual output of goods and services in the near run. Central banks implement monetary policy by influencing the money supply in a given economy. Interest rates and inflation are influenced by the money supply, and both are important predictors of employment, debt costs, and consumption levels.A contractionary monetary policy reduces an economy's money supply. A drop in the money supply is accompanied by a corresponding decrease in nominal output, also known as GDP (GDP). Furthermore, a reduction in the money supply will result in a reduction in consumer expenditure.When the Federal Reserve conducts monetary policy, it primarily effects employment and inflation by influencing the availability and cost of credit in the economy. Furthermore, increased demand for products and services may raise wages and other prices, affecting inflation.