Explain what will happen to the interest rate in the short

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Reference no: EM13205543

An economy is facing the inflationary gap shown in the accompanying diagram. To eliminate the gap, should the central bank use expansionary or contractionary monetary policy? How will the interest rate, investment spending, consumer spending, real GDP, and the aggregate price level change as monetary policy closes the inflationary gap?

In the economy of Eastlandia, the money market is initially in equilibrium when the economy begins to slide into a recession.

a.Using the accompanying diagram, explain what will happen to the interest rate if the central bank of Eastlandia keeps the money supply constant at b.

If the central bank is instead committed to maintaining an interest rate target of r1, then as the economy slides into recession, how should the central bank react? Using your diagram from part a, demonstrate the central bank's reaction.

Continuing from the previous problem, now suppose that in the economy of Eastlandia the central bank decides to decrease the money supply.

a. explain what will happen to the interest rate in the short run.

b.What will happen to the interest rate in the long run?

Reference no: EM13205543

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