With COLAs in effect,if the Fed wishes to avoid a permanent acceleration of inflation after a permanent adverse supply shock,it
A)must respond with an accommodating monetary policy.
B)must respond with a neutral monetary policy.
C)must respond with an extinguishing monetary policy.
D)can choose from accommodating,neutral,or extinguishing monetary policies.

Question

Quizplus · Accepted Answer

When there is a permanent adverse supply shock, the COLAs in effect can lead to a permanent increase in wages and prices. This can trigger an inflationary spiral, where suppliers increase their prices to offset the rising wages, leading to further inflation. To avoid this, the Fed needs to implement a contractionary or extinguishing monetary policy that reduces the money supply and increases interest rates. This will reduce aggregate demand, lower employment levels, and weaken the bargaining power of workers, leading to lower wage pressure and reduced inflationary pressures. Therefore, option C) is the best choice for the Fed in this situation.

With COLAs in Effect,if the Fed Wishes to Avoid a Permanent