During the Presidency of Ronald Reagan, the Federal Reserve Board, decided to en

Question

During the Presidency of Ronald Reagan, the Federal Reserve Board, decided to engage in a contractionary monetary policy that sharply restricted credit in the U.S. According to the Mundell-Fleming model, what would be the impact of this policy on: U.S. income and employment, U.S. interest rates, the value of the dollar, and capital flows between the U.S. and the rest of the world. Please use algebra and diagrams to describe the Mundell-Fleming model and illustrate the impact of this policy. Please separate short-run and long-run effects of the policy

Explanation / Answer

impact of Mundell Fleming model the impact on the contractionary monetary policy When the federalbank/ central bank makes use to curb inflation ,as inflation means an over heated economy ,the economic growth slows down &the interest rates are increased to increase the lending rates.The U.Scentral bank has the target of two precent as if the inflation is high then the economy is over heated & if it is slower than it means the growth is sluggish.

EFFECTS : Higher interest makes loans expensive thus ,people hesitate to buy property,cars & other products. business becomes slow , the economy slows down & if steps to check the rates is not taken ,then contractionary policy may move towards recession. For example 1973 ,inU.S inflation moved from 3.9 % to 9.6% so Federal raised the interest rates from 5,75% to 13 % ,despite inflation ,economic growth was slow. & stagflation situation created. The Fed said that contract policy caused a great depression. Due to recession the stock markets crashed.

Impact on employment : The ratio falls because of an increase in unemployment & also the decrease in labor partipation it becomes difficult to obtain employment in industries & the occupations are more sensitive to contractionary monetary policy..

In short run the factor o f production is stable or fixed here the company wishes to increase out by employing more workers ,but not increase its capital & inthis case we get very small returns &on the other hand maginal cost starts increasing .inthe case their can be increase in demand for ashort period ,at the same time the company may not be able to carry the capacity to increased supply.

LONG RUN : in this type of situation all the factors are quite variable .the company has the power to increase the suden demand of the oroduct .the company can enter the market with price adjustment . the long run period may be more than six month/year , the price elasticity demand can vary . people become more sensitive to the price change & keep buying of their rtequirements. INthe graph-- THE SRAC is U shaped because of small returns

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