Question

Suppose the Federal Reserve announced that it would pursue contractionary monetary policy to reduce the inflation rate.

True or False: If wage contracts have short duration, it would make the recession induced by contractionary monetary policy more severe.

True

False

A recession induced by contractionary monetary policy will be more severe if there is confidence in the Fed's determination to reduce inflation.

True or False: If expectations of inflation adjust quickly to actual inflation, it would make the recession induced by contractionary monetary policy more severe.

True

False

Answer 1

1) The Statement A -  "If wage contracts have short duration, it would make the recession induced by contractionary monetary policy more severe" is considered as TRUE

Reason:- If Federal Reserve adopts Contractionary Policy to fight against inflation, Total Rate of Output of Goods and Services will reduces. Interest rate will shoot up to the very high level. The High Interest rate reduces the purchasing capacity of the people to buy all luxurious as well as basic goods. Thus in turn affects the Production and Sales Volume of all types of Industries. Then Production Sectors will decide to cut-short the Wages of the Employees on a Temporary basis, until the Recession period was restored into Booming condition of the economy.

2) The Statement B - "A recession induced by contractionary monetary policy will be more severe if there is confidence in the Fed's determination to reduce inflation." is considered as TRUE

Reason:- If Federal Reserve follows the contractionary policy, The condition of the economy will be severe as the Investment and Consumption rate will decrease and cause the decrease in the rate of price as well the rate of real GDP value. This situation only evidenced in the US - Recession Period -  2008. So in order to reverse the situation, many innovative economic techniques are used. Then Fed purchased Private Mortage Securities for the safer side in order to re-inject the situation of making credit available to the investors in the future period. This techinque is known as Quantitative Easing.

3) The Statement C - " If expectations of inflation adjust quickly to actual inflation, it would make the recession induced by contractionary monetary policy more severe" is considered as FALSE.

Reason:- Few Political leaders followed the contractionary policy. They had in-sight of thought related to the quick adjustability of Inflation to restoring the economy with the Good Sign. Actually the balance of budget is very essential to control the measures of inflation. The Leaders considered the Stability in the spending of the funds through Tax Savings. They need to ensure the well being of the people. And at the same time too much Purchasing Power of the People will frame the situation of Galloping Inflation in the long-run. So by adopting the contractionary policy, the Federal Reserve will adjust the inflation according to the position of balanced budget - Either Deficit or Surplus. So it wont effect severely if the adjusted inflation worksout very quickly and give the clear way of Booming Economy.