Question

In: Economics

Monetary Policy: You are a Governor on the Federal Reserve Board. Now indicate to the class...

Monetary Policy: You are a Governor on the Federal Reserve Board. Now indicate to the class what the last two digits of your phone number are. These numbers will represent the inflation rate and the growth rate of the US economy respectively. Provide your own unemployment rate scenario that would be consistent with these inflation and growth numbers. Given this scenario, discuss the economic situation in the country. Is it an extraordinary economic environment or a rather plausible occurrence in the natural business cycle? Finally, what monetary policy would you want to pursue and why?

Solutions

Expert Solution

As per the above question (THE WHOLE SCENARIO IS )

inflation rate and growth rate of the US economy is 86% (i.e. the last two digits of the phone no. )

Where as the UNEMPLOYMENT RATE is 15 - 20 %

Because an increase in aggregate demand causes an increase in real GDP. Therefore firms employ more workers and unemployment falls. However, as the economy gets closer to full capacity, we see an increase in inflationary pressures. With lower unemployment, workers can demand higher money wages, which causes wage inflation.

As per the above scenario the economy is in the situation of extraordinary economic environment . As this does not occurs in the natural business cycle . As in the normal economy the growth rate is not likely to be equal to the inflation rate and the rate of inflation is not this much high , As inflation accelerates, workers may supply labor in the short term because of higher wages – leading to a decline in the unemployment rate. And before the rise in the inflation rate to this much limit the government must have taken the right monetary policies .

THE TYPE OF MONETARY POLICY I WOULD LIKE TO PURSUE IS " CONTRACTIONARY MONETARY POLICY "

Because the contractionary monetary policy reduce inflation. They have many tools to do this. The most common are raising interest rates and selling securities through open market operations. The Contractionary Monetary policy is applied when the inflation is a problem and economy needs to be slow down by curtailing the supply of money. The inflation is characterized by increased money supply and increased consumer spending. Thus, the Contractionary policy is adopted with an aim to decrease the money supply and the spendings in the economy. This is primarily done by increasing the interest rates so that the borrowing becomes expensive.


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