Question

Inflation started to creep up in the late 1960's. By 1968, inflation was about 4%, and by 1973, inflation was about 6%. By 1980, inflation was at 13.5%. The Fed, led by Chairman Paul Volcker, engineered a recession that eventually disinflated the economy. Using the economic the concepts learned in class, especially the economics fluctuation model, explain how the Fed disinflates the economy from 13.5% to 3.5%, and what the effects of that disinflation are in the SR and the LR. You can not draw graphs here, so you will need to explain the model and the shifts in words. Be thorough.

Answer 1

US Fed Disinflated economy using Contractionary monetary policy through open market operations by selling government securities as well as raising interest rates which crunched liquidity in market and created shortfall of cash and money rolling. This reduced consumption and aggregate demand which ultimately led to massive price falls and thus inflation reduced to prexisting range of 3.5-4.5% in short run. However in long run the economy kicks back and stabilises causing mid level inflation of 6-7% in long run when aggregate demand revives.