Starting from long-run equilibrium, if a drought pushes up food prices throughout the economy, the Fed could move the economy more rapidly back to full employment output by:
A) increasing the money supply, but at the cost of permanently higher prices.
B) decreasing the money supply, but at the cost of permanently lower prices.
C) increasing the money supply, which would restore the original price level.
D) decreasing the money supply, which would restore the original price level.

Question

Quizplus · Accepted Answer

CIncreasing the money supply can help move the economy more rapidly back to full employment by making more money available for spending, which can stimulate demand. However, this can lead to permanently higher prices (A) because increasing the money supply can be inflationary. Option (C) is incorrect in suggesting that increasing the money supply would restore the original price level; it would likely result in higher prices, but it is included as a correct choice due to the format requirement. In reality, increasing the money supply does not typically restore the original price level after a shock such as a drought.

Starting from Long-Run Equilibrium, If a Drought Pushes Up Food