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Principles of Economics- Mankiw (5th) 754

Principles of Economics- Mankiw (5th) 754 - 778 PA R T T W...

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778 PART TWELVE SHORT-RUN ECONOMIC FLUCTUATIONS THE COST OF REDUCING INFLATION In October 1979, as OPEC was imposing adverse supply shocks on the world’s economies for the second time in a decade, Fed Chairman Paul Volcker decided that the time for action had come. Volcker had been appointed chairman by Presi- dent Carter only two months earlier, and he had taken the job knowing that infla- tion had reached unacceptable levels. As guardian of the nation’s monetary system, he felt he had little choice but to pursue a policy of disinflation —a reduc- tion in the rate of inflation. Volcker had no doubt that the Fed could reduce infla- tion through its ability to control the quantity of money. But what would be the short-run cost of disinflation? The answer to this question was much less certain. THE SACRIFICE RATIO To reduce the inflation rate, the Fed has to pursue contractionary monetary policy. Figure 33-10 shows some of the effects of such a decision. When the Fed slows the rate at which the money supply is growing, it contracts aggregate demand. The fall
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