Final answer:
An open market sale by the Federal Reserve is a contractionary monetary action, shifting the real money supply schedule left and increasing interest rates. Higher interest rates typically lead to decreased consumption and investment, and consequently, lower Real GDP, higher unemployment, and decreased future capital formation and future RGDP.
Step-by-step explanation:
When the Federal Reserve makes an open market sale in response to higher than expected inflation, this is a contraction of the money supply (M⁵). An open market sale by the Fed reduces the amount of money in the banking system, thereby contracting the money supply. As a result, the real money supply schedule shifts to the left.
This contraction of the money supply typically leads to an increase in the interest rate (r). With higher interest rates, consumption (C) and gross investment (I) are likely to decrease because borrowing costs are higher, which can dissuade spending and investment. Consequently, the Aggregate Expenditures schedule will shift downwards.
Regarding the effect on Real GDP (Y), it will likely decrease due to reduced consumption and investment. Here are the impacts on various variables in the economy after this policy action:
- RGDP (Y) - Decrease
- Employment - Decrease (with lower output, demand for labor falls)
- Unemployment - Increase (as employment decreases, unemployment goes up)
- Unemployment rate - Increase
- Interest rate (r) - Increase
- Consumption (C) - Decrease
- Gross Investment (I) - Decrease
- Future capital (Kᵤᵕᵗᵕᵘᵥ) - Decrease (with lower investment)
- Future RGDP (Yᵤᵕᵗᵕᵘᵥ) - Likely to decrease due to lower capital formation
- Firm Confidence (FC) - Could be indeterminate as it depends on other factors not discussed here