Monetary policy???????

Question

can someone plz help me with this question....

1) Some members of congress have proposed a law that would make price stability the sole goal of monetary policy. Suppose such a law were passed.

a) How would the Fed respond to an event that contracted aggregate demand?

b) How would the Fed respond to and event that caoused an adverse shift in short run aggregate-run supply?

In each case, is there another monetary policy that would lead to greater stability in output?

thanx for the help.......

Answer 1

a) How would the Fed respond to an event that contracted aggregate demand?

Answer: The Fed will forecast the expected lower inflation as aggregate demand starts contracting and therefore initiate open market bond purchase program to increase liquidity thus increasing the banks' reserves and induce them to create fresh loans which would lead to higher demand counteracting the contraction in aggregate demand.

As alternative or complementary policy, the Fed may reduce its discount rate and lower the reserve reuirement fo the banks.

b) How would the Fed respond to and event that caoused an adverse shift in short run aggregate-run supply?

Answer: The Fed will forecast the expected higher inflation as aggregate supply curve shifts to the left creating inflationary gap / pressures and therefore initiates open market bond sales program to reduce liquidity thus thus reducing the banks' reserves and thereby reducing their capacity to create further fresh loans which would lead to lower demand counteracting the impact of lower supply on the prices.

As alternative or complementary policy, the Fed may increase its discount rate and increase the reserve requirement fo the banks so that the banks reduce the money supply growth thus reducing the growth in aggregate demand in line with the adverse shift in short-run supply curve.