Final answer:
To address high inflation, the Federal Reserve may increase interest rates to reduce the money supply and control inflation. In contrast, in a slow economy, it could lower rates to stimulate growth. However, there are risks involved with these tactics, including potentially slowing the economy or reducing confidence in fiscal management through inflationary tactics to manage debt.
Step-by-step explanation:
When faced with high inflation, the Federal Reserve (Fed) typically responds by increasing interest rates. This move makes borrowing more expensive, causing banks, businesses, and consumers to reduce their borrowing and spending. This contraction in spending decreases the money supply in circulation, thereby controlling inflation. Alternatively, if the economy encounters slow growth or a recession, the Fed may lower interest rates to encourage borrowing and stimulate economic activity, though this can lead to an overabundance of money in the supply and potential inflation.
In managing monetary policy, the Federal Reserve aims to prevent a repeat of the high inflation rates of the 1970s. If the inflation rate exceeds acceptable limits, the Fed employs a contractionary policy, which includes raising interest rates. Quantitative easing may also be used to avoid deflation by signaling a commitment to maintaining low interest rates, thus boosting spending. Additionally, in situations where the debt-to-GDP ratio rises, high inflation may be tactically included to reduce debt servicing's real value, though this can damage confidence in a country's fiscal management.