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The Federal Reserve expands the money supply by 5%.
a. Use the theory of liquidity preference to illustrate in a graph the impact of this policy on the interest rate.
b. Use the model of aggregate demand and aggregate supply to illustrate the impact of this change in the interest rate on output and the price level in the short run.
c. When the economy makes the transition from its short-run equilibrium to its long -run equilibrium, what will happen to the price level?
d. How will this change in the price level affect the demand for money and the equilibrium interest rate?
e. Is this analysis consistent with the proportion that money has real effects in the short run but is neutral in the long run?
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