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Demand for money

1. Explain how an active policy differs from a passive policy.
2. Explain why the Fed can attempt to target either changes in the money supply or changes in interest rates, but not both.
3. How does monetary policy affect aggregate demand in the short run? How does monetary policy affect aggregate demand in the long run
4. Explain how the short-run Phillips curve, the long-run Phillips curve, the short-run aggregate supply curve, the long-run aggregate supply curve, and the natural rate hypothesis are all related. How do active and passive views of these concepts differ?
5. What is meant by the demand for money? Which way does the demand curve for money slope? Why?

Solution Preview

1. Explain how an active policy differs from a passive policy.
Active policy is a discretionary fiscal or monetary policy that can reduce the costs of unstable private sector while passive policy is discretionary policy that may contribute to the instability of the economy and is therefore part of the problem, not part of the solution.
Passive policy is when the economy is in short run equilibrium at point a with its unemployment exceeding its natural rate. High unemployment causes wages to fall, reducing the cost of doing business. The decline in costs shifts the short-run aggregate supply curve rightward from SRAS130 to SRAS120, moving the economy to its potential output at point b. There is little reason for active government intervention.
The active approach is that the economy is in short run equilibrium, with unemployment exceeding its natural rate. The government employs an active approach to shift the aggregate demand curve from AD to AD.' If the active policy works, then the economy moves to its potential output at point C.

2. Explain why the Fed can attempt to target either changes in the money supply or changes in interest rates, but not both.
The Fed announces it plans to keep prices stable, and expect monetary policy to be expansionary. The short run aggregate supply curve will reflects their ...

Solution Summary

The demand for money is affected by several factors, including the level of income, interest rates, and inflation, as well as uncertainty about the future. The way in which these factors affect money demand is explained in terms of the three motives for demanding money, which is the transactions, the precautionary, and the speculative motives.

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