Question

Principles of Macroeconomics Assignment #7: Monetary Policy Assume the following data for the economy in the United States: . Inflation is at 4.0% and has been rising for the last 3 years from a low of 1.2% Unemployment is at 3.9% and has been falling for the last 6 years from a high of 7.8% The GDP is at $15.36 trillion and has been growing at about 3% for the last 7 years. The NRU is 4.0% Target Inflation is 2.0% Answer the following questions using the data above. EXPLAIN ALL YOUR ANSWERS IN DETAIL 1. What problem is the economy facing? 2. Assume you are a governor on the Federal Reserve Board of Governors. What type of policy (Easy Money or Tight Money) would you recommend to fix the problem you identified in question 1? 3. Which monetary "tool" will the Federal Reserve use to fix the problem you identified in question 17 4. Given the monetary problems and complications discussed in the text, what could happen to make the policy choice (Question 2) ineffective?

Answer 1

1) economy is laden with high inflation.

2) tight monetary policy will be used as a policy measure to counter the inflation.

3) interest rate is going to be the tool used to lower inflation in the economy. Higher interest rates as result of tight monetary policy will reduce demand and hence inflation in the economy.

4) problem could be, when interest rates are high there could be an inflow of funds in the economy from world as now the country is offering higher interest rates. In order to invest in the country money supply will increase again the same level. Hence making policy ineffective.