Question

How does an autonomous tightening or easing of monetary policy by the Fed affect the aggregate demand curve?

Short answer

To investigate: The central bank's response and the impact on monetary policy if an asset price bubble emerges.

Step-by-step solution

Step 1. Concept of asset price bubble occurs 

An asset price bubble occurs when the price of stocks or other assets rises dramatically above their basic value. The central bank formulates monetary policy to keep interest rates and money supply stable throughout the economy.

Step 2. Explanation

The emergence of an asset price bubble is detrimental to the economy. If an asset price bubble develops, the central bank will almost probably modify interest rates in the economy, which will have a direct impact on both inflation and output over time. This will eventually assist to protect the economy from the effects of a burst asset price bubble.

On the other side, monetary policy should raise interest rates in order to diminish the economy's money supply. People prefer to raise their demand when asset values are predicted to rise, which means asset prices inflate the Consumer Price Index.

As a result, it is critical for central banks to respond to the emergence of asset price bubbles in the economy.