Question

For each of the following shocks, describe how monetary policymakers would respond (if at all) to stabilize economic activity. Assume the economy starts at a longrun equilibrium. a. Consumers reduce autonomous consumption. b. Financial frictions decrease. c. Government spending increases. d. Taxes increase. e. The domestic currency appreciates.

Answer 1

A shock in an economy is any event that is not predictable that may have a positive or negative effect on an economy.

Step-by-step explanation:

a. Consumers reduce autonomous consumption

when this happens, policy makers would go for those policies that would ease monetary policy. aggregate demand would fall. interest rate would have to be reduced to bring about stability in economic activities.

b. financial friction decrease

when there is a decrease in financial friction, aggregate demand would be caused to go up. policy makers would have to tighten monetary policy by raising interest rate so as to bring about economic stability.

c. increase in government spending

this causes another increase in aggregate demand. to stabilize economy, policy makers would have to go for policies that favor autonomous tightening

d. tax increase

when taxes increase, spending decreases and the result is a reduced aggregate demand. what policy makers would go for would be autonomous easing of the policy to bring about economic stability.

e. domestic currency appreciation

this would cause imports to increase and exports to reduce. net exports would fall as would aggregate demand. policy makers would go for autonomous easing of the policy for economic stability