Question

If the central bank sells government securities from the private sector money market ,others things being equal,what would the effect be on the following?

a)the economy's monetary base

b)short-term money market interest rates

c)aggregate supply and aggregate demand

d)economic activity and inflation

Answer 1

(a) An open market sell by central bank will decrease the quantity of reserves, which will decrease the monetray base.

(b) Decrease in reserves will lower the credit lending by banks, which will increase interest rate.

(c) Higher interest rate will decrease investment and consumption, which will decrease aggregate demand. But in short run, aggregate supply will stay the same.

(d) Decrease in aggregate demand will shift AD curve to left, which will decrease inflation rate, decrease real GDP and economic activity, and increase unemployment.