Question 4 (30 points) In face of the pandemic experienced by the U.S. economy in 2020-2021, the Federal Reserve Bank increased substantially money supply (TM). (a) What is the impact on the interest rates in the short run? Explain open market operations (buying and selling of government bonds). (3 points) Part I - Keynesian Model Short Run (b) Assuming that the economy starts from an equilibrium in the short run and long run, use the IS-LM diagrams to graphically illustrate the impact of the Federal reserve decision described in part (a) in the short run. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift, v. the short-run equilibrium values. (5 points) (c) Now state in words the impact in the economy in the short run. In particular, explain what will happen in the goods markets and in the money markets. Show the sequence of events. What are the final effects of this policy on prices and eal GDP in the short run? (5 points) (d) Explain what the monetary mechanism is in this context. (3 points) Part II - Classical Model Long Run (e) Explain the relationship between money supply and prices based on the Quantity Theory and the assumptions of the Classical model (write down the quantity theory equation, the assumptions, and the consequent relationship between prices, P. and money supply, M). (3 points) (1) Using the quantity theory equation and the Fisher equation, state and explain the effect of an increase in money supply on prices, inflation, nominal interest rates, and the demand for money in the long run. Show the sequence of events (assume that inflation is zero before this increase in money supply). (5 points) (g) Explain the impact of this policy on real GDP and real interest rates in the long run. Explain what determines real GDP and real interest rate (in the LR). Be complete. (3 points) (h) Explain what money neutrality and the Classical dichotomy are. (3 points) Question 4 (30 points) In face of the pandemic experienced by the U.S. economy in 2020-2021, the Federal Reserve Bank increased substantially money supply (TM). (a) What is the impact on the interest rates in the short run? Explain open market operations (buying and selling of government bonds). (3 points) Part I - Keynesian Model Short Run (b) Assuming that the economy starts from an equilibrium in the short run and long run, use the IS-LM diagrams to graphically illustrate the impact of the Federal reserve decision described in part (a) in the short run. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift, v. the short-run equilibrium values. (5 points) (c) Now state in words the impact in the economy in the short run. In particular, explain what will happen in the goods markets and in the money markets. Show the sequence of events. What are the final effects of this policy on prices and eal GDP in the short run? (5 points) (d) Explain what the monetary mechanism is in this context. (3 points) Part II - Classical Model Long Run (e) Explain the relationship between money supply and prices based on the Quantity Theory and the assumptions of the Classical model (write down the quantity theory equation, the assumptions, and the consequent relationship between prices, P. and money supply, M). (3 points) (1) Using the quantity theory equation and the Fisher equation, state and explain the effect of an increase in money supply on prices, inflation, nominal interest rates, and the demand for money in the long run. Show the sequence of events (assume that inflation is zero before this increase in money supply). (5 points) (g) Explain the impact of this policy on real GDP and real interest rates in the long run. Explain what determines real GDP and real interest rate (in the LR). Be complete. (3 points) (h) Explain what money neutrality and the Classical dichotomy are. (3 points)
