Question

Suppose that each​ 0.1-percentage-point increase in the equilibrium interest rate induces a

​$3

billion decrease in real planned investment spending by businesses. In​ addition, the investment multiplier is equal to

4​,

and the money multiplier is equal to

4

​Furthermore, every

​$9

billion decrease in the money supply brings about a​ 0.1-percentage-point increase in the equilibrium interest rate. Use this information to answer the following questions under the assumption that all other things are equal.

Calculate by how much the real planned investment must decrease if the Federal Reserve desires to bring about an

​$100

billion decrease in equilibrium real GDP.

​$25

billion.

​(Enter your response rounded to one decimal​ place.)

Calculate by how much must the money supply decrease for the Fed to induce the change in real planned investment to bring about an

​$100

billion decrease in equilibrium real GDP.

​$nothing

billion.

Answer 1

(1) Decrease in investment = Decrease in GDP / Investment multiplier = $100 billion / 4 = $25.0 billion

(2)

Given, a 0.1% increase in the equilibrium interest rate induces ​$3 billion decrease in investment. So, when investment decreases by $25 billion,

Increase in interest rate = 0.1% x (25/3) = 0.83%

Also, every ​$9 billion decrease in the money supply brings about a​ 0.1% increase in the equilibrium interest rate. So, when interest rate increases by 0.83%,

Decrease in money supply = $9 billion x (0.83% / 0.1%) = $74.7 billion