Question

Suppose there is a significant decrease in the wealth of consumers, causing an autonomous decrease in aggregate expenditures. Explain the impact this would have on real GDP and the inflation rate in the short run, and how the Fed could try to restore the output level using monetary policy.

Answer 1

When there is a decrease in the wealth of the consumer then the consumption in the market will fall, this will shift the aggregate demand to the left and new equilibrium in the market will be at a lower price rate and lower output, as the price has decreased then inflation will also fall and real GDP will also fall.

As the expenditure has reduced, the Fed will have to increase the money supply and for that they will lower the interest rate in the market. this will increase the investment and aggregate demand reducing the recession in the market and the establising the short run equilibrium.