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As an economy recovers from a recession, what policies would a central bank undertake if it...

As an economy recovers from a recession, what policies would a central bank undertake if it is more "hawkish"? What are the benefits of these policies? What are the drawbacks? (Use the AS/AD model )

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Expert Solution

Answer - If the economic conditions are too hawkish , the interest rates must be higher than potential rates. The bank need to follow the expansionary policy in order to bring the interest rates down through various expansionary measures.

The expansionary measure will raise the money supply in the economy leading to the fall of interest rates in the economy. This will increase the level of investment in the economy , leading to rise in employment and income in economy , rise in AD and hence the real GDP will increase. The economy will be in the phase of expansion.

But , due to the rise of AD, the price level in the economy will increase rapidly , thus bringing the conditions of inflation in economy and overheating the economy. This will lead to the loss of purchasing power of the currency.

Rahul Sunny answered 2 years ago
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