Suppose the economy is in recession and the monetary policymakers lower interest rates in an effort to stabilize the economy. Use an aggregate supply and demand diagram to demonstrate the effects of a monetary easing when the transmission mechanisms are functioning normally and when the transmission mechanisms are weak, such as during a deep downturn or when significant financial frictions are present.

Figure 15-1 Price Level ON OB to point D B to point C B to point A O A to point C 0 SRAS₂ AD1 SRASI AD2 Real GDP Refer to Figure 15-1. One argument against the use of activist monetary policy claims that it can destabilize the economy. For example, suppose we are in a recessionary gap. Expansionary monetary policy is implemented, but there are so many lags that by the time it has its effect, self-regulation has already closed the gap by itself. The end result is a movement from point

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Match the correct policy with its description. Column A 1. 2. 3. 4. During a contraction or recession, the government can do two things: Decrease Taxes Or Increase Spending During a period of excessive inflation (during a period of expansion), the government can do two things: Increase Taxes Or Decrease Spending Increased lending by banks to customers (increased money supply) Lower Interest Rates on loans and bank accounts Increased borrowing from the Fed by banks Decreased lending by banks to customers (decreased money supply) Higher Interest Rates on loans and bank accounts Decreased borrowing from the Fed by banks % 5 M Column B a. Expansionary Fiscal Policy b. Contractionary Monetary Policy c. Contractionary Fiscal Policy d. Expansionary Monetary Policy