Answer :
a. Stagflation:
b. Recession:
To address stagflation, the Federal Reserve (Fed) can utilize its major tools:
- Monetary Policy: The Fed can implement contractionary monetary policy by raising interest rates. This reduces the money supply and decreases aggregate demand (AD), which helps control inflationary pressures associated with stagflation.
- Open Market Operations: The Fed can sell government securities on the open market, reducing the amount of money in circulation. This helps decrease AD and counteract inflationary pressures.
- Reserve Requirements: The Fed can increase reserve requirements for banks, forcing them to hold more reserves and limiting their lending capacity. This reduces the availability of credit, leading to a decrease in spending and inflationary pressures.
To address a recession, both monetary and fiscal policies can be utilized:
- Monetary Policy:
The Fed can implement expansionary monetary policy by lowering interest rates. This stimulates borrowing and investment, leading to increased aggregate demand and economic activity.
- Fiscal Policy:
The government can implement expansionary fiscal policy by increasing government spending and/or reducing taxes. Increased government spending stimulates aggregate demand, while tax cuts put more money in consumers' hands, leading to increased spending and economic growth.
By implementing a combination of these policies, both monetary and fiscal, the government and the Fed can work together to stimulate economic activity, address recessionary pressures, and promote overall macroeconomic stability.
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