Ans) Fed uses expansionary monetary policy to pull economy from the recession. Expansionary monetary policy increases the money supply and hence there is an increase in aggregate demand.
AD curve will shift to the right and the gap will be closed.
Above curve shows that economy is in recession and real output is less than potential output.
Above graph shows that with the implementation of expansionary monetary policy, AD curve has shifted to the right. As a result, economy is back to the potential output Y*.
[Y* is potential output, where there is natural rate of unemployment]
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