Answer to Question #38021 in Macroeconomics for raju

Question

How might monetary policy destabilize the economy?

Answer 1

The Short Run Aggregate Supply curve (SRAS1) is shifting rightward in coordinates of the Real GDP and Price Level (ridding the economy of its recessionary gap), but Fed officials do not realize this is happening. They implement expansionary monetary policy, and the Aggregate Demand curve (AD) ends up intersecting SRAS at point 2 instead of intersecting SRAS1 at point 1. Fed officials end up moving the economy into an inflationary gap and thus destabilizing the economy.