6. Monetary Policy Effects
When the interest rate reaction function---equation 30---is included in the model, monetary policy is endogenous. In other words, there is no exogenous monetary policy variable to change. One can, however, drop equation 30 and examine the effects of exogenous changes in RS. This is done in experiment 6.1.

Experiment 6.1: Increase in the Short Term Interest Rate RS

  • Take RS to be exogenous and increase it by 1.0 in each quarter of the forecast period. Solve the model.
  1. Answer the questions posed at the end of Experiment 5.1. (Experiment 6.1 is another key experiment that you should have a good understanding of.)
  2. What did M1 do in response to the increase in RS? Why?
  3. Remember that -AG is the value of government securities outstanding. This is the open market operations variable of the Fed. Note that -AG increased in the experiment. Why?
  4. What was the effect on government interest payments INTG? How did this affect SGP?