1. Define inflation and discuss the differing impacts of “expected” vs. “unexpec
ID: 1217527 • Letter: 1
Question
1. Define inflation and discuss the differing impacts of “expected” vs. “unexpected inflation.” Which do you believe is the more important type of inflation the government should work to reduce? Explain.
2. What action can the Federal Reserve take to reduce inflation?
3. Using one of the tools available to the Federal Reserve, explain how the Fed would accomplish the action you listed in response to No. 2.
4. Assume the economy is currently operating at the natural rate of unemployment, what affects will the action you listed in response to No. 2 have in the short run on output, price level, and interest rates? Please use the AS/AD and Money Market diagrams to illustrate your answer.
5. Again, assume the economy is currently operating at the natural rate of unemployment, what affects will the action you listed in response to No. 2 have in the long run on output, price level, and interest rates? Please use the AS/AD and Money Market diagrams to illustrate your answer.
Explanation / Answer
1. Inflation is the increase in price level. Expected inflation is the inflation rate which is forecasted or expected by economic agents. While unexpected inflation is deviation from expectation of economic agents. Government should try to reduce unexpected inflation as it can be harmful for economic stability.
2. Federal reserve should build credibility of its actions in the economy. Only if people considers actions of Federal reserve credible, inflation will not turn out to be unexpected.
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