Suppose oil prices rise and the economy suffers a stagflation. If the Fed responds by increasing the quantity of money, then in the short run

Question

Quizplus · Accepted Answer

Increasing the quantity of money in response to stagflation would lead to a short-term increase in real GDP due to the increased spending. However, the price level would continue to rise or remain high due to the already high oil prices. Thus, option B is the correct answer. Option A is incorrect because increasing the quantity of money would not be done to fight inflation, but as a reaction to the already existing stagflation. Option C is incorrect because stagflation is characterized by both high inflation and low economic growth. Therefore, increasing the money supply alone cannot lead to sustainable increases in real GDP or a fall in the price level.

Suppose Oil Prices Rise and the Economy Suffers a Stagflation