posted by Robert on .
In the Monetary policy transmission mechanism, explain what could go wrong between the following points
1. Change in the monetary policy and Change in the money supply
2. Change in the money supply and Change in the aggregate demand curve
Change in the aggregate demand curve and Change in prices, real GDP, and employment
Im not exactly sure what you are asking. So, my response will be rather general in nature.
Monetary policy consists of the things the Federal Reserve can do. Ask yourself, what are these things?
The Fed can 1) change reserve requirements, 2) change the discount rate, or 3) it can engage in open market purchases and sales of government securities. Each of these can have both indended and unintended consequences, or in certain circumstances, have no effect at all. For example, as Keynes argued, if the economy is in a liquidity trap, increasing the money supply will have no effect on aggregate demand.
I suggest you start with a standard IS/LM model. Draw several extreme scenarios (e.g., a liquidity trap where the LM line is flat, or full employment where the IS curve is vertical. The apply a monetary policy and see what happens to interest rates, and real GDP, etc.