3. Suppose That The Japaneses Aggregate Output Is Still Below Potential. Suppose

3. Suppose that the Japaneses aggregate output is still below potential. Suppose that the Japanese Central Bank decides to admittedly target higher employment rates, adding that inflation is not an issue given that it has been low and stable for years.
a) Would you expect a tight or a loose monetary policy?
b) Analyse using IS-LM diagram (Intermediate Macroeconomics – Monetary Policy in the Open Economy: The Mundell Fleming Model)

Expert Answer

This solution was written by a subject matter expert. It’s designed to help students like you learn core concepts.


Step 1/3


A)Would you expect a tight or a loose monetary policy?

If the Japanese Central Bank decides to target higher employment rates and considers inflation not to be an issue, it would likely pursue a loose monetary policy. A loose monetary policy involves increasing the money supply or reducing interest rates to simulate economic activity and employment.

Step 2/3


B) The Mundell Fleming Model

In the IS-LM diagram within the Mundell-Fleming model, a loose monetary policy would shift the LM curve to the right. This is because the central bank is increasing the money supply or lowering interest rates, making money more available in the economy.

This result is lower interest rates, increased investment and higher output.

Step 3/3


The IS curve represents the equilibrium in the goods market.

The combination of the shift in the LM curve and the IS curve results in a higher level of income and output and potentially an improvement in employment rates

Finally, the Mundell-Fleming model assumes a small open economy and the impact of monetary policy on exchange rates is also a crucial factor in the overall analysis.