QUESTION 4 (25%) Suppose that in Region 12 (Federal Reserve Bank of San Francisco), the commercial banks in this region (e.g., Wells Fargo Bank, Redwood Credit Union, etc.) sell $40 billion in government bonds to the Fed through open market operations. Before this open market operations, the amount of money demanded and supplied was $125 billion at a real interest rate of 6%. After the government bonds are traded, the interest rate went down by 2%, and the amount of investment went up by $50 billion (from $20 billion to $70 billion). The actual real GDP is $1,200 billion, and the GDP gap is $200 billion in an economy with a marginal propensity to consume (MPC) of 0.75. After the commercial banks sell the bonds to the Fed, the total change in real GDP will bring the economy to the potential real GDP level (full-employment). a) What is the multiplier in this economy? At a 6% interest rate, is there either a recessionary output gap (negative GDP gap) or an inflationary output gap (positive GDP gap)? What is the amount of the GDP gap? What is the potential real GDP level in this economy? b) As a result of the open market operation, is the Federal Reserve implementing an expansionary or restrictive monetary policy? Please describe the cause-effect chain of events triggered when the banks sell the $40 billion in government bonds. c) Create all the graphs (the Market for Money, the Investment Demand, and Aggregate Demand, Short-Run Aggregate Supply, and Long-Run Aggregate Supply) that will help understand how monetary policy works toward achieving the monetary policy's goal.
QUESTION 4 (25%) Suppose that in Region 12 (Federal Reserve Bank of San Francisco), the commercial banks in this region (e.g., Wells Fargo Bank, Redwood Credit Union, etc.) sell $40 billion in government bonds to the Fed through open market operations. Before this open market operations, the amount of money demanded and supplied was $125 billion at a real interest rate of 6%. After the government bonds are traded, the interest rate went down by 2%, and the amount of investment went up by $50 billion (from $20 billion to $70 billion). The actual real GDP is $1,200 billion, and the GDP gap is $200 billion in an economy with a marginal propensity to consume (MPC) of 0.75. After the commercial banks sell the bonds to the Fed, the total change in real GDP will bring the economy to the potential real GDP level (full-employment). a) What is the multiplier in this economy? At a 6% interest rate, is there either a recessionary output gap (negative GDP gap) or an inflationary output gap (positive GDP gap)? What is the amount of the GDP gap? What is the potential real GDP level in this economy? b) As a result of the open market operation, is the Federal Reserve implementing an expansionary or restrictive monetary policy? Please describe the cause-effect chain of events triggered when the banks sell the $40 billion in government bonds. c) Create all the graphs (the Market for Money, the Investment Demand, and Aggregate Demand, Short-Run Aggregate Supply, and Long-Run Aggregate Supply) that will help understand how monetary policy works toward achieving the monetary policy's goal.
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Transcribed Image Text:QUESTION 4 (25%)
Suppose that in Region 12 (Federal Reserve Bank of San Francisco), the commercial banks in this
region (e.g., Wells Fargo Bank, Redwood Credit Union, etc.) sell $40 billion in government bonds
to the Fed through open market operations. Before this open market operations, the amount of
money demanded and supplied was $125 billion at a real interest rate of 6%. After the government
bonds are traded, the interest rate went down by 2%, and the amount of investment went up by $50
billion (from $20 billion to $70 billion). The actual real GDP is $1,200 billion, and the GDP gap
is $200 billion in an economy with a marginal propensity to consume (MPC) of 0.75. After the
commercial banks sell the bonds to the Fed, the total change in real GDP will bring the economy
to the potential real GDP level (full-employment).
a) What is the multiplier in this economy? At a 6% interest rate, is there either a
recessionary output gap (negative GDP gap) or an inflationary output gap (positive GDP
gap)? What is the amount of the GDP gap? What is the potential real GDP level in this
economy?
b) As a result of the open market operation, is the Federal Reserve implementing an
expansionary or restrictive monetary policy? Please describe the cause-effect chain of
events triggered when the banks sell the $40 billion in government bonds.
c) Create all the graphs (the Market for Money, the Investment Demand, and Aggregate
Demand, Short-Run Aggregate Supply, and Long-Run Aggregate Supply) that will help
understand how monetary policy works toward achieving the monetary policy's goal.
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