Question

1. Comment on the following statement and show your explanation step by step with appropriate diagram: “Argentina is currently suffering from significant inflation (near 20% per year). The Argentinean central bank should not implement contractionary monetary policy in order to reduce inflation because in doing so the unemployment rate in Argentina will permanently increase.” - Show your answer with the help of a diagram and explain the economics. Consider the dynamic AD-AS model of a closed economy where the short-run aggregate supply curve is given by the expression: π = π-1 [1 + λ(Y – Y*)]. Assume that the Argentine economy is initially at full employment.

Answer 1

Contradictory monetary policy mainly used to control monetary expansion known as inflation .Using contradictory monetary policy central bank can reduce the money supply in the economy that will lead to decrease in excessive speculation and unnecessary capital investment.According to the statement given above, Argentina is facing a significant inflation nearly 20% a year , now if Argentinean Central bank implement contradictory monetary policy then aggregate money supply will decrease, nominal interest rate in money market will start to increase thus people will demand for less loan , demand for money will fall thus AD curve will shift downward thus price level will fall with the fall in the real GDP of the economy.Now initially economy was in long run equilibrium with natural rate of unemployment or full level of employment now in short run to lower the inflation rate central bank has to consider increasing rate of unemployment due to fall in real GDP and price level thus actually contradictory monetary policy has some side effects including slow growth of the economy while correcting the problem of inflation , thus Argentinean Central bank should not follow contradictory monetary policy.