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Monetary Policy: Money, Credit, the Federal Reserve

1. If the economy is operating below its potential output, what kind of gap exists? What kinds of fiscal or monetary policies might you use to close this gap? Can you think of any objection to the use of such policies?

2. Define and explain the three lags discussed in monetary policy. For each type identify a problem caused by the lag

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On operating below potential output:

This gap is called the negative output gap or inflationary gap.

In cases like this, monetary and fiscal policies can be implemented.
Monetary policy initiatives: Reduce interest rate to encourage the manufacturing sector to produce more. This will reduce their cost of capital and focus in improving productivity.

Fiscal policy initiatives: Decrease tax to increase disposable income of buyers and sellers. A limited tax holiday may be implemented for new and existing entrepreneurs.
One objection ...

Solution Summary

This is a brief discussion of the economy operating below its potential output. Fiscal and monetary policies that will solve this problem were discussed. It defines and explains the three lags in monetary policy.