The Impact of Monetary Policy on Aggregate Demand, Prices, and Real GDP

Recessions Caused By Drops In Real Money Supply Chart
Recessions Caused By Drops In Real Money Supply Examples
Recessions Caused By Drops In Real Money Supply And Total

Changes in a country’s money supply shifts the country’s aggregate demand curve.

Learning Objectives

Recognize the impact of monetary policy on aggregate demand

As in Chapter 8, the equilibrium in the money market is shown in the top panel of Figure 12; r (or i) is determined at the point where the real money supply M/P is equal to the real money demand L. We can now express this equilibrium in the money market as a new relation between the real interest rate r and real output Y, given values of M. May 12, 2021 The Great Recession began well before 2008. The first signs came in 2006 when housing prices began falling. By August 2007, the Federal Reserve responded to the subprime mortgage crisis by adding $24 billion in liquidity to the banking system. The general strategy of monetary policy is to increase the growth rate of the money supply during periods of recessions (high unemployment and low output growth) and reduce the money supply growth rate during periods of high inflation. For example, suppose there.

Key Takeaways

Key Points

Aggregate demand (AD) is the sum of consumer spending, government spending, investment, and net exports.
The AD curve assumes that money supply is fixed.
The decrease in the money supply is mirrored by an equal decrease in the nominal output, otherwise known as Gross Domestic Product ( GDP ).
The decrease in the money supply will lead to a decrease in consumer spending. This decrease will shift the AD curve to the left.
The increase in the money supply is mirrored by an equal increase in nominal output, or Gross Domestic Product (GDP).
The increase in the money supply will lead to an increase in consumer spending. This increase will shift the AD curve to the right.
Increased money supply causes reduction in interest rates and further spending and therefore an increase in AD.

Key Terms

aggregate demand: The the total demand for final goods and services in the economy at a given time and price level.

Aggregate demand (AD) is the total demand for final goods and services in the economy at a given time and price level. It is the combination of consumer spending, investments, government spending, and net exports within a given economic system (often written out as AD = C + I + G + nX). As a result of this, increases in overall capital within an economy impacts the aggregate spending and/or investment. This creates a relationship between monetary policy and aggregate demand.

This brings us to the aggregate demand curve. It specifies the amounts of goods and services that will be purchased at all possible price levels. This is the demand for the gross domestic product of a country. It is also referred to as the effective demand.

The aggregate demand curve illustrates the relationship between two factors – the quantity of output that is demanded and the aggregated price level. Another way of defining aggregate demand is as the sum of consumer spending, government spending, investment, and net exports. The aggregate demand curve assumes that money supply is fixed. Altering the money supply impacts where the aggregate demand curve is plotted.

Contractionary Monetary Policy

Contractionary monetary policy decreases the money supply in an economy. The decrease in the money supply is mirrored by an equal decrease in the nominal output, otherwise known as Gross Domestic Product (GDP). In addition, the decrease in the money supply will lead to a decrease in consumer spending. This decrease will shift the aggregate demand curve to the left. This reduction in money supply reduces price levels and real output, as there is less capital available in the economic system.

Aggregate Demand Graph: This graph shows the effect of expansionary monetary policy, which shifts aggregate demand (AD) to the right.

Expansionary Monetary Policy

Expansionary monetary policy increases the money supply in an economy. The increase in the money supply is mirrored by an equal increase in nominal output, or Gross Domestic Product (GDP). In addition, the increase in the money supply will lead to an increase in consumer spending. This increase will shift the aggregate demand curve to the right.

In addition, the increase in money supply would lead to movement up along the aggregate supply curve. This would lead to a higher prices and more potential real output.

The Effect of Expansionary Monetary Policy

An expansionary monetary policy is used to increase economic growth, and generally decreases unemployment and increases inflation.

Learning Objectives

Analyze the effects of expansionary monetary policy

Key Takeaways

Key Points

The primary means a central bank uses to implement an expansionary monetary policy is through purchasing government bonds on the open market.
Another way to enact an expansionary monetary policy is to increase the amount of discount window lending.
A third method of enacting a expansionary monetary policy is by decreasing the reserve requirement.

Key Terms

expansionary monetary policy: Traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding.
unemployment: The state of being jobless and looking for work.

Monetary policy is referred to as either being expansionary or contractionary. Expansionary policy seeks to accelerate economic growth, while contractionary policy seeks to restrict it. Expansionary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding. This is done by increasing the money supply available in the economy.

Expansionary policy attempts to promote aggregate demand growth. As you may remember, aggregate demand is the sum of private consumption, investment, government spending and imports. Monetary policy focuses on the first two elements. By increasing the amount of money in the economy, the central bank encourages private consumption. Increasing the money supply also decreases the interest rate, which encourages lending and investment. The increase in consumption and investment leads to a higher aggregate demand.

It is important for policymakers to make credible announcements. If private agents (consumers and firms) believe that policymakers are committed to growing the economy, the agents will anticipate future prices to be higher than they would be otherwise. The private agents will then adjust their long-term plans accordingly, such as by taking out loans to invest in their business. But if the agents believe that the central bank’s actions are short-term, they will not alter their actions and the effect of the expansionary policy will be minimized.

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The Basic Mechanics of Expansionary Monetary Policy

A central bank can enact an expansionary monetary policy several ways. The primary means a central bank uses to implement an expansionary monetary policy is through open market operations. Commonly, the central bank will purchase government bonds, which puts downward pressure on interest rates. The purchases not only increase the money supply, but also, through their effect on interest rates, promote investment.

Because the banks and institutions that sold the central bank the debt have more cash, it is easier for them to make loans to its customers. As a result, the interest rate for loans decrease. Busin

Recessions Caused By Drops In Real Money Supply