Question

According to activists, which of the following would be an appropriate monetary policy action for a period of unemployment?

Select one:

a. a reduction in government spending

b. the purchase of government securities by the Fed

c. an increase in the reserve requirement

d. a reduction in the tax rate on personal income

e. an increase in the discount rate

Answer 1

Answer

As it is a period of unemployment, thus optimal monetary policy will be that policy that will shift Aggregate demand(AD) curve to the right and which will result in increase in output and decrease in unemployment.

Monetary Policy are those policies in which Fed changes it's money supply in order to change in Aggregate demand(AD).

When Money supply increases, LM curve shifts to the right which results in rightward shift of AD curve and that;s what we wanted. So we have to increase money supply.

Change in taxes and government spending does not effect money supply and thus are the incorrect options because they are not part of the monetary policy.

Increase in reserve requirements will result in decrease in money multiplier and hence will result in decrease in money supply and thus is also incorrect.

Increase in discount rate means that commercial bank borrowing are now costly and hence they will borrow less and will result in decrease in money supply and hence is incorrect.

When Fed buys government securities(open market purchase) this means they bring more liquid in the economy and thus Money supply will increase and LM and thus AD will shift to the right and hence option (b) is the correct answer.

Hence, the correct answer is (b) the purchase of government securities by the Fed.