a) The European Central Bank would like to increase the interest rates in the economy. What open…

a) The European Central Bank would like to increase the interest rates in the economy. What open…

a) The European Central Bank would like toincreasethe interest rates in the economy. What open market operation (OMO) action should the central bank take? Explain in detail the OMO process and its implications for the cash rate, interest rates, inflation
and GDP. Draw by hand the effect of the OMO process using the MD-MS diagram.
(4 marks)
Question 3
a) Refer to the table below.
Price Level
Real GDP Demanded (in Billions)
Real GDP Supplied (in Billions)
230
1600
380
250
1250
750
260
1100
1100
270
1000
1500
280
800
1800
290
600
2000
i. Using the information provided in the table above, plotthe Aggregate Demand & Aggregate Supply curves by hand. Insert your drawing below and do not forget to indicate macroeconomic equilibrium.
(3 marks)
ii. Assume potential GDP is at $1100 Billion. Illustrate potential GDP on your drawing. Is there an inflationary or recessionary gap? Explain why.
(2 marks)
iii. Briefly explain what your answer in (ii) means for movements in the money wage rate (nominal wages) as the economy moves from its short-run macroeconomic equilibrium to its long-term macroeconomic equilibrium.
(1 marks)
b) Assume that Germany’s macroeconomic equilibrium is currently greater than potential GDP. The German government also starts a massive expansion of the railway system which will double the total length of the railway system. Using the AD-AS model, explain carefully the short and long-run effects of this event on the German economy. Draw by handthe appropriate AD-AS diagram to support your explanation.