On pg. 255 in your text, The Economics in Practice describes the increase in foo

Question

On pg. 255 in your text, The Economics in Practice describes the increase in food prices around the world in 2008. Since food, in large measure, affects the real income of households, increasing prices will eventually push up wages and have an impact on the aggregate supply curve. Central banks were very worried about the prospects for inflation becoming generalized. To stop inflation, what would the Fed be likely to do? What are the consequences for the economy? Specifically, what would be the effects on employment and unemployment given the actions taken by the Fed? Respond to at least two of your classmates’ postings.

Explanation / Answer

The measures taken by central ban or federal bank are other wise called monetory policy measures

Monitory Policy Measures to control inflation:

To reduce inflation, the monitory measure that can be adopted is reducing the money supply. i.e., Central bank (Fed) contracts the money supply, or drains out money from the market;

It has options like increasing Reverse repo rate, CRR and SLR rate.

Reverse Repo rate: it is the rate at which the central bank (federal bank) borrows money from the banks, when the central bank increases the reverse repo rate, the commercial banks are always happy to lend money to central bank, since it is secure and gives a healthy returns.

CRR is the cash reserve ratio, it is the cash (in the from of a deposit), a commercial bank need to maintain with the central bank (federal bank). By increasing the CRR ratio, the commercial banks need to deposit more money in the central bank (federal bank), and hence money supply can be reduced.

SLR is statutory liquidity ratio, it is the amount that the commercial bank needs to maintain in the form of cash, gold or government approved securities, to meet any time demand of the bank customers (who deposited money in the respective banks).

By increasing the SLR rate, there will be a reduction of money available to the commercial banks, thus decreasing lending and increasing the interest rates

So by increasing the reverse repo rate, CRR and SLR rates money supply can be reduced. The decreased money supply increases the interest rates, motivating the public to save rather than spending (consumption and investment spending), and this decreases the aggregate demand, decreasing the inflation.

Specifically, what would be the effects on employment and unemployment given the actions taken by the Fed? Respond to at least two of your classmates’ postings.

Effect on employment

The above measures will contract the money supply in the market, reducing investments and aggregate demand. The other effects of the central bank measure are it increases the value of the currency and also there will be a rise in interest rates.

With an appreciation in the currency value, the exports become costlier reducing the production further, thus a reduced aggregate demand and reduction in exports results into lower out put which forces the companies to downsize employees, eventually reducing the employment.

If these measures prolongs it results in cyclic unemployment and recession

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