Answer to Question #47872 in Macroeconomics for Sarah

Question

Monetary policy in the context of aggregate supply/ aggregate demand

1- An economy is starting to exhibit signs of an economic boom. The central bank decides to change monetary policy to deal with an economic boom, describe in point form what will occur to the monetary policy, (MP), the real interest rate, and to the aggregate demand curve?

2- Contrast your answer above if the central bank was pursing an inflation control target of between 1 and 3%. Do you think the central bank will step in, why or why not?

Answer 1

1. In this case contractionary monetary policy will be implemented, it is a form of monetary policy in which a decrease in the money supply and a increase in interest rates are used to correct the inflationary problems of a business-cycle expansion. In theory, contractionary monetary policy can include selling U.S. Treasury securities through open market operations, an increase in the discount rate, and an increase in reserve requirements. In theory, open market operations are the primary tool of contractionary monetary policy. Contractionary monetary policy is often supported by contractionary fiscal policy. An alternative is expansionary monetary policy.
2. If the central bank was pursing an inflation control target of between 1 and 3%, there will be no need for the central bank to step in, because during the economic boom inflation is controlled.