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Suppose Russia’s inflation rate is 100 percent over one year but the inflation rate in Switzerland...

Suppose Russia’s inflation rate is 100 percent over one year but the inflation rate in Switzerland is only 5 percent. Using the DD-AA model show the effects of contractionary monetary and fiscal policy on output and the exchange rate. Assume the policies are temporary. Use a separate graph to analyze the effects of each policy.

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Contractionary monetary policy through raising interest rates or increased reserve requirement the Central bank decreases money supply in market which reduces aggregate demand and hence Real GDP and Prices both fall.

Similarly when contractionary Fiscal policy is adopted through increased taxes or reduced government spending the money supply in market reduces and disposable incones too. This causes aggregate demand to fall and hence prices fall causing decrease in inflation. Even real GDP falls as results.

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