If an economy is in a recession and government decides to use open market purchases to close the contractionary gap, would it impact SRAS, AD or LRAS the most?

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

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The greatest impact of open market operations will be on aggregate demand in an economy. 

The most important effect of expansionary open market operations, which closes a contractionary gap, is that they increase the amount of investment that businesses are willing to engage in.  When the money supply increases, it becomes easier to borrow money.  Firms are then more willing to borrow so that they can invest in capital goods.  There is also an impact on consumer spending.  When the costs of borrowing drop, consumers are more able to borrow money to buy “big ticket” items such as cars and houses.  Both consumption and investment are parts of aggregate demand.  Therefore, the immediate impact is on aggregate demand (AD).

This will, of course, have some impact on long range aggregate supply (LRAS).  As firms invest, their capacities increase.  This can work to increase LRAS.  However, that effect is not as strong or as immediate as the effect on AD, aggregate demand.

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