If initially, $\vec { M }$ = 5%, $\vec { v }$ = 3%, $\vec { P }$ = 2%,and $\vec { Y } _ { R }$ = 6% and then because of economic uncertainty $\vec { v }$ falls to 1%,what should the Fed do?
A) Quietly raise
$\vec{ Y } _ { R }$ to 8% to offset the decrease in
$\vec { v }$ .
B) Publicly lower
$\vec{ M }$ to 3% so that
$\vec{ M }$ -
$\vec { v }$ stays constant at 2%.
C) Publicly demonstrate a commitment to keep
$\vec{ M }$ +
$\vec { v }$ at 8% by raising
$\vec{ M }$ .
D) Quietly raise
$\vec{ M }$ without telling anyone,as only unexpected inflation is expansionary.

Question

Quizplus · Accepted Answer

The decrease in velocity ($\vec{v}$) implies a decrease in aggregate demand, which could lead to lower output, hence recession. Therefore, the Fed needs to increase aggregate demand to offset the effect of the decrease in velocity. Option C suggests raising the money supply ($\vec{M}$) to keep the sum of $\vec{M}$ and $\vec{v}$ constant, which would increase aggregate demand and prevent recession. Option A is not the preferred strategy as it would raise inflation expectations, which may not be desirable. Option B is not a good choice because lowering the money supply ($\vec{M}$) would decrease aggregate demand, making the situation worse. Option D is not a good choice because it is not transparent and could lead to uncertainty about the Fed's policy objectives.

If Initially M⃗\vec { M }M = 5 v⃗\vec { v }v

If Initially $\vec { M }$ = 5 $\vec { v }$