In the section “A Shock to the Economy,” we explored the impact of an increase in government…

In the section “A Shock to the Economy,” we explored the impact of an increase in government purchases with an unchanged interest rate target by the Fed. 

a. In order to maintain an unchanged interest rate target, will the Fed have to increase or decrease the money supply? Illustrate with a diagram of the money market. 

b. Suppose the Fed instead decides to pursue a completely passive monetary policy—leaving the money supply unchanged. What will happen to the interest rate? (Illustrate with another diagram of the money market.) 

c. Under a passive monetary policy, does the change in government spending have more or less of an initial  impact on the stock market (compared to the policy  of maintaining an unchanged interest rate target)?

 

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