Decrease the short-term interest rate in europe

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On June 5, 2003, the European Central bank acted to decrease the short-term interest rate in Europe by half a percentage point, to 2 percent by increasing the money supply through open market operations. (r*=2% in Money market after the increase in Money supply) The interest rate cut was made because European countries were growing very slowly. a) What effect did the bank hope the action (of cutting interest rates) would have on the economy? Assume that investment spending is a function of interest rates. Be specific. Draw what happens in the Money Market and the Goods Market. b) What is the direction of change on I and Y in the goods market? c) What kind of monetary policy (expansionary or contractionary) is the European Central Bank undertaking in the scenario provided above? State how you arrive at your conclusion.

Reference no: EM131109598

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