Question

You are the new leader of Egypt’s central bank. Egypt has been experiencing high inflation, and your task is to reduce that inflation rate.

a.     What policy actions can your central bank take to reduce inflation? (3 points)

b.     In a well-labeled graph, show how your policy actions affect the trade-off between inflation and unemployment in the short and long run. (5 points)

c.     Explain how inflation and unemployment change over time as a result of your policy actions (3 points).

Answer 1

a)if i am the leader of central bank and have got the task to reduce the inflation rate in egypt then i will follow contractionary fiscal policy and tight monetary policy. insimple words i can say to reduce the level of inflation i simply have to reduce the supply of money in the economy because when there is lots of money in the economy people demand a lot and eventually price level increases and leads to inflation. so here a contractionary fiscal policy and tught monetary policy will help to reduce the supply of money in the economy which will help to reduce inflation.

b) as we know the philips curve depicts the trade off between unemployment and inflation in the short run, we are going to use that. in the short run there is inverse relationship between the two and in the long run there is no trade off between the two.

c) inflation and unemployment changes over time. when contractionary fiscal policy is being applyed the government starts to reduce expenditure and increases the tax rate ehich ultimately reduce the supply of money in the economy. as a result inflation reduces but unemployment increases because the government expenditure reduce will lead to decline in employment and income in the economy. with the help of tight monetary policy the central bank increases the bank rate and so less money is available for credit creation. this way there will be less money flow in the economy and inflation will decline. the increase in bank rate will result in increase in rate of interest because as we know when moneysupply decreases rate of interest increases and vice versa, the increase in rate of interest will make people invest less in the economy which will eventually lead to increase unemployment.