Check Your Understanding

1. Question

   Assume that there is an increase in the demand for money at every interest rate. Using a diagram, show what effect this will have on the equilibrium interest rate for a given money supply.

2. Question

   Now assume that the Fed is following a policy of targeting the federal funds rate. What will the Fed do in the situation described in Question 1 to keep the federal funds rate unchanged? Illustrate with a diagram.

3. Question

   Suppose the economy is currently suffering from a recessionary gap and the Federal Reserve uses an expansionary monetary policy to close that gap. Describe the short-run effect of this policy on the following.

   1. the money supply curve

   2. the equilibrium interest rate

   3. investment spending

   4. consumer spending

   5. aggregate output