The state of the US economy is one where the price level has decreased from 110 to 120. Manufacturers are finding that their inventories are increasing. Foreign countries are finding that the exchange rate of the US dollar is down. Americans are substituting imported goods where they can. The claims for unemployment are at an all time high and consumers are postponing credit purchases.
1. Draw and label graph that best describes the situation above.
2. If you were president Bush what would you do in response to the situation described above?
3. If you were the head of the FED, what would you do in response to the situation described above?
Fiscal stimulus policy generally includes lowering taxes or increasing government spending. Monetary stimulus policy is to increase the money supply.
1. Graph: To accurately depict the situation described, one possible graph to consider is an aggregate demand and aggregate supply (AD-AS) model.
- The vertical axis represents the price level.
- The horizontal axis represents real GDP (output).
- The AD curve should shift leftward, indicating a decrease in aggregate demand. This is because the lower price level suggests decreased consumer spending, as well as substitution of imported goods.
- The AS curve should shift rightward, indicating an increase in aggregate supply. This is due to the increased inventories of manufacturers, higher unemployment claims, and consumers postponing credit purchases.
2. Response as President Bush: As president, there are several potential policy actions that could be taken in response to the described situation. Some possible actions might include:
- Implementing fiscal stimulus: This could involve measures such as reducing taxes to boost disposable income, potentially encouraging increased consumer spending and investment. Additionally, increasing government spending on infrastructure projects or other industries could also help stimulate the economy.
- Encouraging domestic production: Promoting policies that support domestic manufacturing and industries might help address the issue of increased inventories. This could include tax incentives or subsidies to incentivize production and employment within the country.
- Addressing foreign exchange rates: Collaborating with the Treasury Department to monitor and potentially adjust foreign exchange policies could help stabilize the US dollar exchange rate and potentially mitigate any negative impacts on trade.
3. Response as the head of the Federal Reserve (FED): As the head of the FED, some possible responses to the described situation could be:
- Implementing monetary stimulus policy: The FED could consider increasing the money supply through measures such as open market operations (buying bonds) or reducing interest rates. By increasing the money supply, the FED aims to stimulate economic activity, encourage borrowing, and boost spending.
- Adjusting interest rates: Lowering interest rates can make borrowing more affordable and encourage consumer spending. Additionally, lower interest rates might also discourage saving and incentivize investment.
- Managing inflation expectations: In the described situation, the decrease in the price level might indicate potential deflationary pressures. The FED could communicate and take actions to manage inflation expectations, aiming to avoid a deflationary spiral that could further exacerbate the economic situation.
It's important to note that these responses are hypothetical and would depend on various factors such as the specific economic circumstances, timing, and consensus among policymakers.