Assume the United States economy has the following: GDP is $15,600 billion up fr
ID: 1160015 • Letter: A
Question
Assume the United States economy has the following:
GDP is $15,600 billion up from $13,400 billion four years ago.
Unemployment is at 4.0% down from 7.7% three years ago.
Inflation is at 3.7% up from 1.2% four years ago.
NRU = 4.0%
Target Inflation is 2.0%
1. Explain in detail the problem the country is facing.
2. Should the Federal Reserve adopt an easy money or tight money policy? Explain!
3. Which policy tool should the Federal Reserve use to carry out the policy you recommended in Question 2? Detailed explanation as to why the choice is correct and how the tool works to address the problem.
4. What could happen to make the policy you recommended in Question 2 ineffective? On this question, be sure to read the section in your text beginning on page 372. Don’t just make something up. It will take a paragraph or two to answer this question because you need to relate the specific complication to the scenario described in the question.
Explanation / Answer
Ans
The economy is suffering from higher inflation because there is enough growth and unemployment is at natural level but only inflation is above target rate.
2 it needs to adopt tight monetary policy because only tight monetary policy reduces Aggregate demand and thus inflation
3 The fed needs to increase selling of securities through open market operations. This will decrease money supply in economy and raise interbank lending rates. The banks will inturn reduce their own lending rates. This will lead to less investment and consumption Hence Aggregate demand will fall and inflation will be curtailed.
4 eclxcess reserves with banks will make this policy ineffective because they will still have money to expand credit