You’ve been asked to spend a week or so as the Fed chairman. It will turn out to

Question

You’ve been asked to spend a week or so as the

Fed chairman. It will turn out to be a very in-

teresting week. If your goal is to stabilize infla-

tion and economic activity, what would be your

response to these three events? Consider each

event individually, independent from the others:

(a)

A rapid rise in the stock markets rapidly in-

creases people’s wealth;

(b)

Chilean citizens get a sudden taste for Buf-

falo hot wings (they must be made in Buf-

falo); and

(c)

firms begin to grow anxious about the de-

cline in consumer confidence.

Explanation / Answer

(a) With a rapid rise in stock market that will increase people's wealth rapidly, consumption of consumers will increase also at a good pace. Becuase noe people will be having more disposable income than before, to which aggregate demand will witness a high increment. With increase in AD, price level will also increase that will bring inflation type situation. In such condition, contraction monetary policy could be used as a measure to control the situation. By increasing bank rate, SLR and CRR rate, selling securities in open market etc will reduce AD to bring price levl back to position.

(b) With increase in taste for bufalo hot wings demand will increase for that good having impact on price level. Again the above measures will be used.

(c) To combat the decline in consumer confidence, firms will adopt various customer relationship managment; customer retention and winning back strategies. Such as providing club membership, membership discount, reducing price to increase customer base and so on. This will reduce the price level. In such condition, expansionary policy will be helpful.

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