Author Question: Would the Federal Reserve respond more aggressively with interest rate cuts in a recession caused by ... (Read 45 times)

ashley · **on:** Jun 29, 2018

Would the Federal Reserve respond more aggressively with interest rate cuts in a recession caused by a decrease in spending, as in the 2001 recession, than in a recession caused by an increase in oil prices, as in the 1974-75 recession?

What will be an ideal response?

Question 2

How does the production possibilities frontier illustrate opportunity cost?

What will be an ideal response?

chinwesucks · **Reply #1 on:** Jun 29, 2018

Answer to Question 1

The inflation rate responds differently in the two recessions. A large increase in oil prices decreases real GDP (or slows down the growth rate), but increases inflation. The large decrease in spending decreases real GDP and decreases inflation. The Fed wants to increase real GDP, but they also want to prevent an increase in inflation. Cutting interest rates increases aggregate demand which increases real GDP and increases inflation. With a recession caused by a drop in spending, the rate of inflation declines, which allows the Fed to more aggressively cut interest rates.

Answer to Question 2

The negative slope of the production possibility curve illustrates the concept of opportunity cost. Moving along the production possibility frontier, producing additional units of a good requires that the output of another good must fall. This sacrifice is the opportunity cost of producing more of the first good.