The economy of a hypothetical country has been stable for two or three years with very low unemployment. Wages have been gradually increasing during this time. Now an aggressive policy of increasing...

1. The economy of a hypothetical country has been stable for two or three years with very low unemployment. Wages have been gradually increasing during this time. Now an aggressive policy of increasing tariffs on foreign goods imported into the country results retaliatory actions from the other countries against the country’s products and services. This causes great loss of business in the country and results in significant portion of workers losing their jobs.

Given this scenario, insert your answers below each of the following questions.

1. What kind of economic gap will start to occur (inflationary or recessionary)?


2. Which of these graphs, Figure 1 or Figure 2, depicts this economic gap?

Figure 1: Graph of the economy showing demand shifted to the right.

Figure 2: Graph of the economy showing demand shifted to the left.

1. What part of the Federal Reserve’s congressional mandate does this scenario trigger (price stability and maximum sustainable employment)?


2. What kind of monetary policy might be helpful to stabilize the economy (expansionary or contractionary)?


3. What specific monetary policy tools does the Federal Reserve have available to use in this scenario?


4. Explain in detail, how should the Federal Reserve use each of these tools to maximize their effect in stabilizing the economy, what will be the likely effect of each monetary tool’s use on the money supply, and the resulting impact on the economy?

Extracted text: LRAS $1 D1 D2 P1 P2 s1 D2 D1 Real GOP Q2 -Q1


Extracted text: D2 LRAS $1 D1 P2 P1 D2 s1 D1 Real GDP