Anything will helpreally :)! A major concern of the Federal Reserve is to mainta

Question

Anything will helpreally :)! A major concern of the Federal Reserve is to maintain stable prices. It attempts to do so through influencing the money supply and interest rates. You are to examine the impact and consequences of both inflation and deflation. Address the following areas in your presentation: Identify the causes of both inflation and recession or deflation. Identify the ways inflation and deflation can damage the economy and the society What policies can the Federal Reserve use in trying to prevent inflation or deflation in the macro economy? What are some of the short term uncertainties and longer run risks in using these policies ? If you must accept a tradeoff between higher prices or fewer jobs, which is the better choice and why?

Explanation / Answer

Another common cause of inflation is a rise in production costs,which leads to an increase in the price of the final product. Forexample, if raw materials increase in price, this leads to the costof production increasing, which in turn leads to the companyincreasing prices to maintain steady profits. Rising labor costscan also lead to inflation. As workers demand wage increases,companies usually chose to pass on those costs to theircustomers.

Inflation can also be caused by international lending andnational debts. As nations borrow money, they have to deal withinterests, which in the end cause prices to rise as a way ofkeeping up with their debts. A deep drop of the exchange rate canalso result in inflation, as governments will have to deal withdifferences in the import/export level.

Finally, inflation can be caused by federal taxes put onconsumer products such as cigarettes or fuel. As the taxes rise,suppliers often pass on the burden to the consumer; the catch,however, is that once prices have increased, they rarely go back,even if the taxes are later reduced. Wars are often cause forinflation, as governments must both recoup the money spent andrepay the funds borrowed from the central bank. War often affectseverything from international trading to labor costs to productdemand, so in the end it always produces a rise in prices.

Deflation damage to economy: deflation hasthe side effect of increased unemployment since there is alower level of demand in the economy, which can lead to an economicdepression.

Inflation damage to economy:When inflationaffects an economy, to maintain the same level of living standardsyou would have to pay more. That is you would have to pay more forsame amount of goods and services you had used prior to inflation.Remember, your income may not increase at the same rate asinflation.

At the time of inflation, financial planning becomes difficult. Thereason - the value of money decreases with inflation. It wouldaffect the pensioners more than the ones who are currentlyemployed.

In an inflation-affected economy, retirement planning is nearlyimpossible because the premium you pay would have to be high if youwant to keep the same quality of life.

People tend to save less in an economy affected by inflationbecause the price of services and goods are ever time high andthere is nothing or very less leftover income available tosave.

However, economists opine, many of the issues stemming frominflation are caused by the widespread consumer panic and fear andnot by the market alone.

Federal reserve policies to preventdeflation:To counter deflation, the Federal Reserve (theFed) can use monetary policy to increase the money supply anddeliberately induce rising prices, causinginflation. Rising prices provide an essential lubricant forany sustained recovery because businesses increaseprofits and take some of the depressive pressures off wagesand debtors of every kind.

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