Question

You are asked to spend a week or so as the Fed chairman. It turns out to be a very interesting week. If your goal is to stabilize inflation and economic activity, what would be your response to these three events? Consider each event individually, independent from the others:

(a) a rapid rise in the stock markets rapidly increases people’s wealth.

(b) Chilean citizens get a sudden taste for Buffalo hot wings (they must be made in Buffalo).

(c) firms begin to grow anxious about the decline in consumer confidence.

Answer 1

(a) A rapid rise in the stock markets that rapidly increases people’s wealth would mean that for the same level of real interest rate, output will rise because of the rise in demand for consumer goods. This will probably lead to inflation and as chair of the Fed you should raise interest rates to quiet inflation and reduce the gap.

(b) If Chilean citizens get a sudden taste for Buffalo hot wings that must be made in Buffalo, this will have a similar effect as the answer before. The answer is to raise interest rates.

(c) Firms begin to grow anxious about the decline in consumer confidence.