Question

Explain how expansionary monetary policy can lead to inflation, and discuss the types of individuals who are hurt by unexpected inflation.

Answer 1

Expansionary monetary policy reduces the federal funds rate. This can be done by conducting open market operations and buying government securities, reducing the reserve requirement or the discount rate. Now this step increases the excess reserves that the banking system has and it increases their lending capacity. With more loans provided by the banks, investment and consumption both are increased and this increases the aggregate demand. Real GDP and price level both are increased and we experience a demand pull inflation

There are several economic agents who was suffered by sudden unexpected inflation. This includes people with fixed income such as those retired pensioners whose pension is not adjusted for inflation. There is a reduction in the purchasing power with increased price level so, this distorts the consumption pattern. It also distorts the income distribution when it hurts the creditors but benefit the debtors.