Answer to Question #283539 in Macroeconomics for kika

Question

6. Suppose that declining resource supplies reduce potential output in each period by 4%. What kind of monetary policy would be needed to maintain a zero rate of inflation at full employment?

Answer 1

Solution:

The reduction in potential output will tend to affect the level of unemployment and increase inflation levels.

The best method the government can undertake to control inflation is through a contractionary monetary policy. The goal of a contractionary policy is to reduce the money supply within an economy by decreasing bond prices and increasing interest rates.

As such, a zero rate of inflation will be maintained at full employment.