Question

.Suppose there was a large increase in net exports. If the Fed wanted to stabilize output,...

.Suppose there was a large increase in net exports. If the Fed wanted to stabilize output, it could

a. decrease the money supply, which will increase interest rates.

b. increase the money supply, which will reduce interest rates.

c. decrease the money supply, which will reduce interest rates.

d. increase the money supply, which will increase interest rates

need explanation

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Answer #1

According to IS-LM model, Increase in Large Exports will shift IS curve to the right and thus increases Aggregate Output. Thus In order to stabilize the Output, LM curve must shift to the left(Note : LM curve must shift to the right then Aggregate Output will increase).

In order to shift LM curve to the left, Money supply must decrease. Thus Fed will decrease Money supply. Finally, Leftward shift of LM curve(considering Rightward shift of IS curve) will result in definite increase interest rate.

Hence, Money supply should decrease, which will result in increase in interest rate.

Hence, the correct answer is (a) decrease the money supply, which will increase interest rates..

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