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Explain the linkages in the causal chain when the Fed conducts a contractionary monetary policy. What...

Explain the linkages in the causal chain when the Fed conducts a contractionary monetary policy. What will be the ultimate effect on GDP?

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Answer - For conducting the contractionary monetary policy , the fed will have the tools of raising the reserve requirement , increasing the discount rates or selling the government securities in the open market. This will reduce the supply of money in the economy and raise the interest rates . Due to this , the investment and the consumption will decline leading to the fall in value of AD. This will decrease the value of Real GDP and lead to lower price levels and increased unemployment.

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