Question

Which of the following examples illustrates the danger of countercyclical monetary policy? select all that apply:

O the fed lowers the interest rate to stimulate the economy out of a recession but is unable to reduce the unemployment rate.
O aggressive expansionary monetary policy causes the economy to overshoot potential gdp and swing into an inflationary gap.
O high interest rates implemented by the fed to reduce inflation cause the economy to go into a recession.
O the fed raises interest rates to fight a bubbling housing market, but that has no effect and the bubble continues.

Answer 1

Countercyclical monetary policy involves risks such as overstimulation leading to inflation and overdampening causing a recession. Correct examples indicating the danger of such policies include cases where the Fed's action fails to adjust unemployment, causes an inflationary gap, leads to a recession due to high-interest rates, or cannot deflate a housing market bubble.

Step-by-step explanation:

The examples provided illustrate the potential dangers of countercyclical monetary policy, which aims to mitigate the extremes of business cycles. Two primary risks are associated with this type of policy: overstimulation leading to inflation and over-dampening that might precipitate a recession.

• If the Federal Reserve lowers interest rates to combat a recession and is unsuccessful at reducing unemployment, it indicates that monetary policy may not always efficiently affect the real economy, possibly due to other prevailing conditions.
• When an aggressive expansionary monetary policy leads to an economy exceeding its potential GDP, creating an inflationary gap, it showcases the risk of overstimulation and subsequent unwanted inflation.
• If the Fed's increase in interest rates to temper inflation results in a recession, it exemplifies the delicate balancing act required to manage aggregate demand without triggering negative economic outcomes.
• Raising interest rates to curb a housing market bubble that continues to grow despite these efforts highlights the limitations of monetary policy in influencing certain asset markets and the complex dynamics at play.

In conclusion, while countercyclical monetary policy is a fundamental tool for managing economic stability, it carries the risk of either causing inflation by pushing aggregate demand too far right or causing a recession by reducing it too far left.