The following graph represents the money market for some hypothetical economy. This economy is similar to the United States in the sense that it has a central bank called the Fed, but a major difference is that this economy is closed (and therefore does not have any interaction with other world economies). The money market is currently in equilibrium at an interest rate of 3% and a quantity of money equal to $0.4 trillion, designated on the graph by the grey star symbol. Suppose the Fed announces that it is raising its target interest rate by 75 basis points, or 0.75 percentage points. To do this, the Fed will use open-market operations to (increase/decrease) the (demand for/supply for) money by (buying bonds from/selling bonds to) the public. Use the green line (triangle symbol) on the previous graph to illustrate the effects of this policy by placing the new money supply curve (MS) in the correct location. Place the black point (plus symbol) at the new equilibrium interest rate and quantity of money. Suppose the following graph shows the aggregate demand curve for this economy. The Fed's policy of targeting a higher interest rate will (reduce/increase) the cost of borrowing, causing residential and business investment spending to (increase/decrease) and the quantity of output demanded to (increase/decrease) at each price level. Shift the curve on the graph to show the general impact of the Fed's new interest rate target on aggregate demand.

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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The following graph represents the money market for some hypothetical economy. This economy is similar to the United States in the sense that it has a central bank called the Fed, but a major difference is that this economy is closed (and therefore does not have any interaction with other world economies). The money market is currently in equilibrium at an interest rate of 3% and a quantity of money equal to $0.4 trillion, designated on the graph by the grey star symbol.

Suppose the Fed announces that it is raising its target interest rate by 75 basis points, or 0.75 percentage points. To do this, the Fed will use open-market operations to (increase/decrease) the (demand for/supply for) money by (buying bonds from/selling bonds to) the public.

Use the green line (triangle symbol) on the previous graph to illustrate the effects of this policy by placing the new money supply curve (MS) in the correct location. Place the black point (plus symbol) at the new equilibrium interest rate and quantity of money.

Suppose the following graph shows the aggregate demand curve for this economy. The Fed's policy of targeting a higher interest rate will (reduce/increase) the cost of borrowing, causing residential and business investment spending to (increase/decrease) and the quantity of output demanded to (increase/decrease) at each price level.

Shift the curve on the graph to show the general impact of the Fed's new interest rate target on aggregate demand.

INTEREST RATE (Percent)
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0
Money Demand
0.1
Money Supply
0.2
0.3
0.4
0.5
MONEY (Trillions of dollars)
0.6
0.7
0.8
New MS Curve
New Equilibrium
(?)

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