Question

For each of the following situations, identify whether the Federal Reserve is likely to pursue an expansionary or a contractionary monetary policy.
a. The unemployment rate is at 0.5 percent: .
b. The economy is experiencing record growth in GDP: .
c. The unemployment rate is at 15 percent: .
d. Inflation has reached 10 percent, a recent high: .
e. A hurricane recently demolished a major city, causing a major recession: .

Answer 1

Answer:

a) Contractionary b) Contractionary c) Expansionary d) Contractionary e) Expansionary

Explanation:

Contractionary Monetary Policy

This a tool or policy employed by the Central Bank of a country or the federal reserve to fight inflationi or too much liquidity in an economoy. Put in another ways, when there is inflation, it is a sign of an overheated economy and it could be as a result of government intervention causing so much cash or liquidity in circulation.  The central bank reduces money supply and increase interest rates to reduce liquidity, borrowing and spending. A contractionary policy therefore is a restrictive monetary policy that is aimed at slowing economic growth to what is healthy in a system.

Expansionary Monetary Policy

This monetary policy is simply the opposite of the Contractionary policy where the Central Bank uses its tools and reserves to boost or stimulate the economy. The aim of the policy is to increase aggregate demand and bring the economy out of recession or impeding recession into an healty state. Some of the policies include increasing money supply and lowering interest rates to boost growth in the Gross Domestic Product (GDP)

To answer the question, we look at each situation and find out if its an overheated economy or a recessed economy and that determines the policy

The unemployment rate is at 0.5 percent:

According to the Federal Reserve, an healthy unemployment rate in the economy is from 4 to 5%, hence, this rate is so low it is indicative of an overheated economy the policy therefore, is Contractionary

The economy is experiencing record growth in GDP

Growth in GDP is good in fact, GDP growth is the aim of every economy, but an over active rate will lead to inflation and inflation is not good. Hence the Contractionary policy will be put in effect

The unemployment rate is at 15 percent

Since the acceptable rate of unemployment is 4%-5%, 15% is too high, the economy needs to be stimulated to reduce the rate, hence, the Expansionary Monetary Policy will be pursued

Inflation has reached 10 percent, a recent high

High inflation is indicative of an over-active or over stimulated economy, it will drive prices of goods and services up and it is not healthy in the long-run, the monetary policy to be pursued is Contractionary

A hurricane recently demolished a major city, causing a major recession

The Expansionary Monetary Policy is a major tool to bring an economy out of a recession. Circulation of money is increased, liquidity is increased, interest rate by banks are lowered and aggregate spending increases.