Question (5 points) Consider an economy operating at point A in the figure below
ID: 1165015 • Letter: Q
Question
Question (5 points) Consider an economy operating at point A in the figure below. The unemployment rate, the flation rate, and the expected nflation rate are 5%. Suppose the central bank believes the inflation rate is too high, and it undertakes a policy that decreases the inflation rate to 0%. In the questions below, you are asked to trace the effects of the central bank policy in the short run and the long run. There are five questions that build on one anothe so go slowly Actual and Phillips curve infation P SRPC 2% 0% 3% 4% 5 K 19/20> 15 OF 20 QUESTIONS COMPLETED MacBook AirExplanation / Answer
a) In order to decrease the inflation rate, the Feds would want to pursue a monetary policy. That is because Monetary policy directly affects the money supply, and money supply affects the prices of goods. Hence the feds want to decrease the prices of goods, hence it will want to reduce the money supply and in order to do so it will follow a contractionary monetary policy.
b) The central bank wants to decrease money supply in the economy. Therefore it will sell bonds in market for loanable funds. Because consumers will buy bonds in exchange for money. Therefore they will give money to central bank. Hence money will be taken off from the economy and its supply would decrease.
c) This action will cause money supply to decrease and decrease in inflation. This is because people will have less money with them, hence they will demand less goods. The sellers will have to decrease the price of their goods to clear the market. Hence, inflation will decrease.
d) When money supply is decreased and prices are driven down, the economy will move from point A to D . This is because prices will decrease and this will reduce firms profits. So they will employ less workers to reduce their losses. Therefore temporarily some workers will be out of work and unemployment will rise at 7%.
e) When workers and firms come to expect the new inflation at 0%, they will renegotiate a lower salary because prices have decreased. Therefore, worker's salary will go down and firms will employ more people. Therefore the unemployment will go to it's original value at 5%. Hence the economy will move from D to C.