What Impact Will An Unanticipated Increase In The Money Supply

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Econ 214
Problem Set 5

1. What impact will an unanticipated increase in the money supply have on the real interest rate, real output, and employment in the short run? How will expansionary monetary policy affect these factors in the long run? Explain.

The money supply in an economy is the benchmark by which interest rates are determined. The supply of money is directly tied into the amount of money that can be loaned and borrowed in various capacities. The more money there is to loan, the less “expensive” it is to borrow that money. This is because when there is an increase in the money supply, the demand for that money fluctuates as well. This causes an increase in the overall amount of money being exchanged, and in turn,
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This obviously is lost economic activity that can cause ripple effects across the market. When the general price level is stable however, the economy becomes appealing to investors, and causes them to spend their money in the market. This confidence that investors gain is a huge asset to economic growth and development. When people and businesses are confident that their money is going to be put to good use, they are much more likely to spend it. Domestically, price stability is important for the government, and the Fed to be able to maintain fiscal policies. The Central Bank is also affected by the stability of prices when it makes monetary adjustments and investments. Therefore, it is vital for the Fed to monitor and attempt to stabilize prices as much as possible.

4. Compare and contrast the impact of an unexpected shift to a more expansionary monetary policy under rational and adaptive expectations. Are the implications of the two theories different in the short run? Are the long-run implications different? Explain.

When monetary policy is created, there are 2 popular theories that guide the actions of decision makers. One of these policies is Rational Expectations. The theory of Rational Expectations is based on the presumption that the economic future of a market can be systematically