Question

Giving this situation in 1980: Real GDP growth rate = -0.2% Inflation rate = 13.5% Unemployment rate = 7.1% Federal Funds Rate = 13.35%

1. Explain which monetary policy tool could be used in this situation.

2. What are some potential concerns if this action is implemented?

3. What is the economic term for this type of situation?

Giving this situation in 1968: Real GDP growth rate = 4.8% Inflation rate = 4.2% Unemployment rate = 3.6%

1. Given that this was during the Vietnam War, explain which type of policy could be used in this situation.

2. What are some potential concerns if this action is implemented?

3. Is it possible to have monetary policy and fiscal policy working in opposite directions? Explain.

Answer 1

Scenario 1:

1.

Expansionary monetary policy will be applied and as a part of it, open market operations will be used. Here, government securities will be purchased to increase the money supply in the economy. It will encourage consumption and investment expenditure. It will increase the aggregate demand and economy will start growing again.

2.

The one potential concern is liquidity trap when the increase in the money supply lead to decrease in interest rate, but it will be unable to increase the demand for money in the market. It makes the monetary policy to be ineffective. The second concern is the inability to change the consumers and investors expectations of the economy. It will not make the economy to revive.

3.

This type of situation is called as Stagflation. Here, GDP growth is very slow, but inflation and unemployment is very high in the economy.

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