Question

Congrats, you are just named head of the SCS Central Bank (with one good-and one type of money). You are given the directive to maintain a constant 10% increase in the price level each year.

What information would you request and how would you execute monetary policy to achieve this directive? What effect might this policy of targeting an increasing price level, at any cost, have on other segments of the economy?

Show and explain calculations and potential repercussion of this policy.

Answer 1

As a head of the SCS Central Bank, i would request information regarding the prevailing demand conditions, flow of money and other macroeconomic factors which gets affected due to execution of monetary policy. It is important to keep a close check on various variables of the economy, such as National Income, GDP, foreign trade, exchange rates etc.

The policy of targeting an increasing price level, at any cost, will have a major impact on other segments of the economy. A constant increase in the price level for a prolonged period is inflation. Such inflationary condition will lead to reduction in level of demand, reduction in level of investment, as a result reduction of level of production and supply in the economy and would lead to reduction in level of employment. Thus such increase in price level would not be effective for the economy in the long run.