Below you will find four different scenarios. Each one represents a different qu

Question

Below you will find four different scenarios. Each one represents a different quarter of the year with the initial situation representing the first three months of the calendar year. Your goal is to help keep Gross Domestic Product positive as high as possible, inflation low and stable, and unemployment low and stable. I am asking you to take on the role of Janet Yellen, Chair of the Federal Reserve System There will be many statements in each of the quarters. As you make your decision to raise, lower, or leave the money supply the same you should be specific about why you chose that particular action and what impact you believe it will have. Each quarter has a new set of situations and they don’t build on the previous quarter. You will need to probably write at least one paragraph to defend your actions for each quarter of the year. It’s not enough to just say “lower the money supply” you must have solid reasons and you must be able to accurately predict the outcomes of that decision

Quarter One - Consumer income has been on the rise and it is predicted to rise again in the first quarter of this year. Mexico and Canada have been forecast to have a very good first quarter also with the income of their average citizen on the rise. Investment spending is predicted to remain the same this first quarter. Will you raise, lower, or leave the money supply the same and why?

Quarter Two - Inflation is on the rise. After several quarters of 1-2% increases this quarter predicts inflation to increase an additional 4 or 5%. Unemployment has dropped to all time lows in the United States. Unfortunately, our major trading partners have seen unemployment go up in their countries and expect it to rise even further in this quarter. Business spending is thought poised to decline while consumer confidence is up. Would you raise, lower, or leave the money supply the same and why?

Quarter Three – Six months of hard work have just ended. People are projected to set anew spending record. Investment spending will likely rebound as orders for manufactured goods jumped at the end of the 2nd quarter. Trade restrictions have been reduced through recent negotiations. The stock market has recorded increased trading activity and that trend will continue. Will you raise, lower, or leave the money supply the same and why?

Quarter Four (last three months of the calendar year) – Inflation is now running at 6% on an annual basis. The trade deficit has grown steadily through the year but very prominently during the last quarter. Forecasters say that if this trend continues we might see inflation end up in double digits. There appears to be no end in sight to the building that’s going on and consumers have taken on a whopping amount of debt. Will you raise, lower, or leave the money supply the same and why?

Explanation / Answer

The problem is trying to indicate impact of money supply on the economy. In other words you have to decide on the monetary policy for keeping GDP at high level. In monetary policy government will introduce necessary changes in money supply to maintai balance or equilibrium in the money market. This equilibrium is considered as ideal situation.

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Now consider the situation of first quarter. Income of the consumer is on the rise. It will rise further in the first quarter. As you know consumption of a person is directly related with the income. So increase in income will raise the demand for consumable goods. If you want to satisfy this increased demand you have to increase supply of commodities. It requires additional investment. If it does not increase, then supply will be less than commodity demand. Market will be disequilibrium. Price will rise.

In order to overcome it goverment must increase the supply of money. It can lower compulsory reserve ratio or lending rate to banks. Thus interest rate will be low. Borrowing will be cheap. More fund will be available to lend. It will induce business to borrow more for investment. Production will move up. Equilibrium in commodity demand and supply in future will be maintained.

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In second quarter inflation is on the rise. As a result unemployment has dropped. It will not better off the economy until inflation is checked. It will reduce demand in future as cost of consumable goods are on the rise. So government should reduce the supply of money. It is possible by increasing compulsory reserve ratio or interest rate. Also it can sale government bond to public. This effort will pump out additional money from the economy. Ultimately price will come down to the normal level.

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In quarter three, is indicating a rosy picture. After six month of hard work, people are now ready to spend huge amount. Thus commodity demand will move up. To satisfy it, supply of commodity should rise. Already investment has increased. Trde restrictions are reduced. Stock market is moving i the positive direction. So situation is ready for boosting investment, production and supply of commodity. It will generate adequate commodities to satisfy demand. Thus no further action is needed now in the monetary policy. Supply of money should be maintained at the same level.

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In fourth quarter trade defecit is rising. So import of commodities is going up. It is occuring since domestic production is inadequate. So you have to boost up domestic production. Import must be lowered and export must rise. Under this situation, government has to encourage improvement in domestic production. It should channelize investment in export oriented sector. Import should be restricted by tightening licencing or imposing quota. Tax can be imposed to imported goods. Thus solution is to increase domestic production through adequate investment in the selected sector. Hence money supply should increase in selected areas. So that trade defecit can come down. At the same time inflation is checked by increasing domestic production.

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