You are a recent hire at the Labor Department and are asked to assess monetary policy's effects on labor markets using a stylized DSGE model with sticky prices. You read the Fed's policy statement, and given the negative output gap they decide to ________, which would ________ and ________.
A) reduce taxes; reduce labor demand; push real wages down
B) increase the FFR; reduce consumption; shift labor supply out
C) use a fiscal expansion; lower taxes today; increase taxes in the future
D) change inflationary expectations; raise the target inflation rate; raise real wages
E) reduce the FFR; increase labor demand; push real wages up

Question

Quizplus · Accepted Answer

Given the negative output gap, the Fed is likely to use expansionary monetary policy to increase aggregate demand and stimulate economic growth. This can be done by reducing the Federal Funds Rate (FFR), which would decrease the cost of borrowing and increase investment and consumption. With sticky prices in the labor market, reducing the FFR would increase labor demand, which would then push real wages up. Therefore, the correct option is to reduce the FFR, increase labor demand, and push real wages up, which corresponds to option E.

You Are a Recent Hire at the Labor Department and Are