Question

There has been a five-year drought all over the US because Martians have decided to direct the sun directly for trying to destroy the earth. Martians long ago created Earth as a large planet to store their pet humans who have multiplied beyond their expectations. So the Martians have decided to start over by trying to lower the human population, especially in the US.

What type of shock would occur in the economy? Where do you see inflation and GDP growth?

What are the options that we have to solve this economic situation?

If inflation maintains it's inertia regardless of what is done above, what would be the best monetary policy? What will be the result in the short run? What is the result in the long run?

Answer 1

This type of shock is called adverse supply shock andbecause of drought the economy faces shortage of food supply which raises its demand and hence prices. This results in hyperinflation at the same time stagnant growth innGDP because consumption doesnot increases.

Overall the economy enters stagflation mode.

Policies include increasing government budget to import more food crops and thus increasing aggregate supply in market through Privatisation and Deregulation and control of wages.

As per monetarist views, reducing inflation through contractionary monetary policy is best even if it reduces growth and GDP and employment because this type of unemployment is price worth paying for higher inflation.

In short run it creates degrowth and unemployment rises and prices stabilise However in long run even growth returns to normalcy and economy enters into stability mode due to higher consumption because of low inflation .