Question

The economy is currently in a recession with high unemployment and low output.

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

Draw and upload a graph of the Aggregate Demand and Aggregate Supply model to illustrate the impact of the expansionary monetary policy in returning the economy to the natural level of output.

Be sure to carefully label all components of your graph.

Answer 1

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]