Suppose in an election year, the economy entered an economic boom. At the same t
ID: 1108620 • Letter: S
Question
Suppose in an election year, the economy entered an economic boom. At the same time, clear signs of inflationary pressures were apparent. How might the central bank with a primary goal of price stability react? How might members of the incumbent political party who are up for re-election react?
In this case, the appropriate monetary policy is to loosen or tighten monetary policy, increasing or decreasing interest rates to curb the emerging inflationary pressures in pursuit of the long-run goal of price stability. In contrast, it is likely that the politicians due for re-election would be more concerned with the economic boom in the economy and be in favor of a cut or an increase in interest rates. In the absence of influence over an independent central bank, they may push for immediate increase or decrease in government spending or reductions or increases in taxes.
Explanation / Answer
Correct Answer:
Tighten
Increasing
A Cut
Increase
Reduction
To bring the price stability, the central bank will apply tightening or contractionary monetary policy and it will involve increase in interest rate. As a result, the households and firms will be discouraged from borrowings and ugly buying habits will be curbed to achieve the stable prices. Though, the political party will act differently. These ruling parties will increase the government spending and or reduce the tax. These initiatives will increase the disposable income, available for spending. Hence, more consumer spending takes place to continue the economic boom.