Assume the Fed implements restrictive monetary policy.Which of the following is the most likely result in an AD-AS framework with an upward sloping AS-curve?
A)the interest rate will increase but output, prices, and real money balances will fall
B) the interest rate, output, and prices will all decline
C)prices and output will fall, but real money balances will increase
D)real money balances will remain unchanged, since money supply and prices will decrease proportionally
E)real money balances and prices will fall proportionally

Question

Quizplus · Accepted Answer

When the Fed implements restrictive monetary policy, it reduces the money supply, which leads to higher interest rates. This leads to a decrease in investment and consumption spending, resulting in a decrease in output. As output decreases, firms have less pricing power, leading to a decrease in prices. Finally, since real money balances depend on the nominal money supply and price level, a decrease in both leads to a decrease in real money balances. Therefore, the most likely result is that the interest rate will increase but output, prices, and real money balances will fall, as stated in option A.

Assume the Fed Implements Restrictive Monetary Policy