Assume that the economy is hit with successive positive demand shocks, lowering unemployment and inflation. What...

Assume that the economy is hit with successive positive demand shocks, lowering unemployment and inflation. What policy would the central bank pursue if the decrease in inflation lowered inflation below their target (assuming the CB is operating under an inflation rule for monetary policy).

Expert Solution

Inflation is the rise in the prices of goods and services which can be the daily items such as food, clothing, housing, recreation, transport, consumer staples, industrial goods etc.. The inflation measures the average price rise over time.

Inflation targeting is a policy carried out by the central bank. It varies the monetary policy inorder to maintain a suitable inflation rate. The goal of inflation targeting is used to stablize the flow of price within the economy.

If the inflation level is below the target level, the demand for goods and services will be lower than the usual demand and this may result in the fall of economy. This low demand can also result in the rise of unemployment in the economy. Thus inorder to control these situations, the central bank will try to reduce the interest rates. Reducing the interest rates is done to rise the level of inflation and thus results in the growth of economy.

Thanks !..

Rahul Sunny answered 11 months ago

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