The Fed conducts an open market purchase of securities. Explain the effects of this action in the short run and the long run on:
a)The quantity of money
b)The quantity of money demanded
c)The nominal interest rate
d)The real interest rate
e)Real GDP
f)The price level
Take a shot, but do a little research first.
In the graph, money supply would shift the the right, and the aggregated demand would shift to right. If what I just said is right...
For short run:
a) increase
b) increase
c) decrease
d) decrease
e) increase
f) indrease
For long run:
d) the real interest rate would go back up to where it was since the money demanded would shift to the right.
f) price level would go back up since the aggregated supply would shift to the left.
I don't know if this is right. Can you please help me with this?
Thank you.
Certainly! Let's break down the effects of an open market purchase of securities by the Federal Reserve (the Fed) on the various variables you mentioned in the short run and the long run:
a) Quantity of Money:
In the short run, when the Fed conducts an open market purchase of securities, it increases the money supply. This is because the Fed buys securities from financial institutions, injecting money into the economy. Therefore, in the short run, the quantity of money increases.
In the long run, the quantity of money is determined by the Fed's monetary policy actions. If the Fed continues to conduct open market purchases, it can increase the quantity of money in the long run. However, if the Fed decides to reverse its policy and conduct open market sales of securities, it can decrease the quantity of money.
b) Quantity of Money Demanded:
In the short run, an increase in the quantity of money available in the economy often leads to an increase in the quantity of money demanded. This is because individuals and businesses have more money available to spend, invest, and lend.
In the long run, the quantity of money demanded is influenced by several factors, including the interest rate, expectations about future inflation, and the level of real economic activity. Changes in these factors can lead to shifts in the demand for money, which may affect the quantity of money demanded in the long run.
c) Nominal Interest Rate:
In the short run, the increase in the quantity of money resulting from the open market purchase tends to lower the nominal interest rate. This is because the increased money supply leads to more competition among borrowers for funds. As a result, lenders are willing to accept lower interest rates to lend out their excess money.
In the long run, the nominal interest rate will adjust based on the equilibrium between the supply and demand for loanable funds. However, it's important to note that the nominal interest rate is influenced by various other factors beyond the scope of an open market purchase.
d) Real Interest Rate:
In the short run, the decrease in the nominal interest rate resulting from the open market purchase will likely lead to a decrease in the real interest rate. The real interest rate is the nominal interest rate adjusted for inflation. Since the nominal interest rate decreases more than inflation, borrowers benefit from a lower cost of borrowing.
In the long run, the real interest rate will depend on various factors, including the equilibrium between the supply and demand for loanable funds, inflation expectations, and productivity growth.
e) Real GDP:
In the short run, the increase in the quantity of money can stimulate spending and investment, leading to an increase in real GDP. With more money available, individuals and businesses are more likely to engage in economic activity, resulting in higher output and potentially increased employment.
In the long run, changes in real GDP are primarily determined by factors such as labor supply, productivity growth, and technological advancements, rather than changes in the quantity of money.
f) Price Level:
In the short run, an increase in the quantity of money may lead to an increase in the price level. This is because the increase in money supply stimulates aggregate demand, leading to higher overall spending and potentially causing inflationary pressures.
In the long run, the price level is driven by factors such as the quantity of money, velocity of money, and real economic activity. If the increase in the quantity of money is offset by an increase in real GDP, the long-run effects on the price level may be limited. However, if the increase in the quantity of money is not matched by an increase in real GDP, it can lead to sustained inflationary pressures.
It's important to note that the effects of an open market purchase can be influenced by other factors and may vary depending on the specific economic circumstances. Additionally, the analysis provided here simplifies the complex interactions of the economy for illustrative purposes.