Principles of Macroeconomics / Unit 12 MAC 1127 worked example, 60 to 90 seconds
Tracing a Policy Through to Output and Prices
The idea
Take one action and follow it to the end of the chain, naming the direction at every link. Do not skip to the conclusion: most errors happen at a middle link, and a skipped link cannot be checked.
In practice
The economy sits in a recessionary gap, so the central bank buys bonds. Reserves rise. The federal funds rate falls, and other rates follow it down. Cheaper borrowing raises investment and purchases of durable goods. The lower rate also makes domestic assets less attractive, so the currency falls and net exports rise. Aggregate demand shifts right by the multiplier times those initial changes. In the short run, with the economy below potential, output rises and the price level rises a little. Now contrast a contraction: sell bonds, reserves fall, rates rise, investment and net exports fall, aggregate demand shifts left, and output and the price level fall.
Where people slip
How much of the movement lands on output and how much on the price level depends on where the economy sits against potential, which is unit eight's zones. Monetary policy shifts aggregate demand; it does not decide by itself what that shift produces.
Your place on the trail
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