Question

2) Describe the problem of stagflation and the problems it creates for policy makers. 3) Discuss the problems of adverse selection and moral hazard in financial markets. 4) Discuss how the external finance premium can evolve over the business cycle.

Answer 1

2) Stagflation - It is the phase of rising inflation and reducing output and increasing unemployment.

The traditional definition of Philips curve states that there is an inverse relationship between unemployment and inflation.

It means there is always an increase in one ( let say inflation) and decrease in other. (say unemployment)

The problem that stagflation causes for policy makers is that policy available can't reduce both unemployment and inflation at once.

One probable solution to stagflation is reduction in economics dependency on oil.

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