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The economy is currently experiencing an economic boom with low unemployment and high output. The economy...

The economy is currently experiencing an economic boom with low unemployment and high output.

The economy is currently experiencing an economic boom with low unemployment and high output.

The Federal Reserve could conduct contractionary monetary policy to restore the economy to its natural rate of output.

Draw and upload a graph of the money market to illustrate the effect of an open-market operation that would be consistent with contractionary monetary policy.

Be sure to carefully label all components of your graph.

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Answer #1

The open market operation, when the central bank is following a contractionary monetary policy, is designed to wipe out the liquidity from the system so that the money supply reduces in the economy.

When the central bank sells the government bonds in the open market operation, the money supply reduces and intersects the demand curve at higher interest rates. Higher interest rates reduce the quantity of money in the economy.

Higher interest rates and lesser quantity of money in the economy is the objective of contractionary monetary policy in order to reduce the economic activity to the desired extent.

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