How a fall in stock prices would affect output and inflation

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Reference no: EM131141997

In late 2000, there were signs the U.S. economy might be heading into a recession. Some argued that the rise in energy prices during 2000 was the cause of the economic slowdown. Others pointed to the decline in the stock market and argued that this decline in wealth would reduce consumption spending. Assume the economy is initially at full employment.

(a) Using the ADI-IA (inflation adjustment) framework, explain how a rise in energy prices would affect output and inflation in the short run.

(b) Using the ADI-IA framework, explain how a fall in stock prices would affect output and inflation in the short run.

(c) Suppose you are chair of the Federal Reserve Board. If your only concern is keeping inflation stable, would you raise interest rates or would you lower them if you believe energy prices are the cause of the slowdown? Would you raise interest rates or would you lower them if you believe the stock market decline is the cause of the slowdown?

(d) Suppose you are chair of the Federal Reserve Board. If your only concern is keeping unemployment stable, would you raise interest rates or would you lower them if you believe energy prices are the cause of the slowdown? Would you raise interest rates or would you lower them if you believe the stock market decline is the cause of the slowdown?

Reference no: EM131141997

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