Question

Suppose that rising productivity increases potential output in each period by 4%. What kind of monetary policy would be needed to maintain a zero rate of inflation at full employment?.

Answer 1

Assume that each period's potential production increases by 4% as productivity rises. Each period, the money supply should be reduced by 4%.

How can monetary policy manage inflation?

One frequent strategy for managing inflation is to implement a contractionary monetary policy. By lowering bond prices and raising interest rates, a contractionary policy seeks to reduce the amount of money available in an economy. As a result, prices drop, inflation slows, and consumption declines.

Is the greatest approach to lower inflation through monetary policy?

Increasing interest rates in the economy and tightening monetary policy will help to lower inflation if it is too high, but they will also likely slow down economic development and increase unemployment.

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