Question

In the past, some people believed that the Federal Reserve routinely expanded the money supply during presidential election years in order to stimulate the economy and help the incumbent president. For this question, assume that the Fed increases inflation by 3% in every election year.

a. Describe the effect on the economy during election years if market participants expect 0% inflation.

Answer 1

If market participants expect 0% inflation during election years, their adjusted behavior might dampen economic growth.

Step-by-step explanation:

In the scenario where market participants expect 0% inflation during election years, the effect on the economy would be different from the assumed 3% increase. When the Federal Reserve increases inflation by 3%, it stimulates the economy by encouraging spending and investment.

However, if market participants expect 0% inflation, they may adjust their behavior accordingly and not spend or invest as much, which could potentially dampen economic growth during election years.