You've been asked to spend a week or so as the Fed chairman. It will turn out to be a very interesting week. If your goal is to stabilize inflation and economic activity, what would be your

response to these three events? Consider each event individually, independent from the others:

(a) A rapid rise in the stock markets rapidly in-creases people's wealth;

(b) Chilean citizens get a sudden taste for Buffalo hot wings (they must be made in Buffalo); and

(c) firms begin to grow anxious about the decline in consumer confidence.

(a) A rapid rise in the stock markets rapidly increases people's wealth.

Explanation:

When fed decides to stabilize the inflation and economic activities, then to deal with the increase in people?s wealth, the fed will use contractionary monetary policy. Contractionary monetary policy is used by the fed to decrease the money supply in the market. Fed can sell treasury bills to the banks and the households, which reduces the money holdings by the people. Also, the fed can increase the interest rate due to which getting loans will cost higher to the people due to which people will demand lesser loans and decide to save money; this also reduces the money holding of the people.

(b) Chilean citizens get a sudden taste for Buffalo hot wings (they must be made in Buffalo);

Explanation:

An increase in the demand for Buffalo hot wings will increase the price and the inflation as well, so the fed will use contractionary monetary policy to reduce the price level, and that, in turn, reduces the inflation level in the market.

(c) Firms begin to grow anxious about the decline in consumer confidence.

Explanation:

A decline in consumer confidence implies a reduction in the economic activities of households. It leads to a decrease in the consumption and investment by the people that lead to lower the output produced in the market. Fed will use expansionary monetary policy to increase the money supply in the market so that people can consume more and invest more with having more money in their hands.