Question

Addressing inflation using Fiscal and Monetary Policy tools.

Scenario - The US economy is currently experiencing high rates of inflation. You have Fiscal and Monetary policy tools available to address this problem:

Q1: To attack the problem of inflation you must select one Monetary Policy tool and one Fiscal Policy tool. Write down the name of your Fiscal Policy tool and your Monetary Policy tool.

Q2: Please explain why you selected the tools that you selected and why you did not select the other choices? Do this for both monetary and fiscal policy tools!

Q3. Thoroughly and completely explain how your solution (both the monetary and the fiscal policy tool) would work to solve the problem of inflation, and indicate the impact your solution would have on at least 5 key economic variables. Be specific.  

Please answer all question since all questions are connected to each other. Thanks :)

Answer 1

1) For high rate of inflation

Fiscal Policy: Increasing the Taxes.

Monetary policy: Open market selling of Bonds.

2) In the fiscal policy, I choose to increase the tax and nothing other like increasing the government expenditure or reducing the taxes because increased taxes will reduce the disposable income of the people and this will reduce the demand. A reduction in the demand will reduce the inflation in the economy.

Monetary policy: I choose to sell the bonds in the open market because doing so will reduce the excess money in the market. People will have less money in their hands and this will reduce the demand they are making. decreasing the inflation rates.

3. Five key economic variables we choose are price, employment, interest rates, output, and demand.

Fiscal policy: An increase in the taxes will reduce the disposable income of people and they will demand less. This could lead to a reduction in the aggregate demand in the economy and it will shift the aggregate demand curve to the left at a lower price and lower output. The decrease in inflation and output will also affect the employment in the economy and it will be reduced leading to increased unemployment. As the income with people will decrease the interest rates have to be reduced so that the money market remains in the equilibrium.

Monetary policy: Open market selling of the bonds will decrease the money supply in the market. A decreased money supply will lead to an increase in the interest rate which will also decrease the investment in the market and lead to a decreased aggregate demand. A fall in the output and aggregate demand will increase the unemployment. Bur our overall goal to reduce the inflation and decrease the price will be achieved.