Question

1. During an expansionary phase on the business cycle, explain what type of problem the United States will face. In order to correct, this problem what type of policy will the Federal Reserve Bank and the U.S Government engage in? Explain each policy in detail.

Answer 1

An expansionary phase is the one in which there is an increase in the economic activity, that stimulates the aggregate expenditure. Expansion can come from consumption investment or government initiative. Under this phase of business cycle, the economy experiences the demand pull inflation where real GDP as well as rate of inflation both are increased

The major problem that the country experiences is that of a demand pull inflation. To counter this inflation, the federal reserve Bank is likely to use contractionary monetary policy. Money supply will be reduced by increasing the federal funds rate. This will discourage aggregate expenditure and bring down the inflation rate. In this process however the real GDP is also reduced.

Government can also discourage aggregate expenditure by reducing the government expenditure on goods and services and increasing the tax rate. With reduced disposable income under the tax policy, aggregate expenditure decreases and this reduces the rate of inflation as well as the real GDP.