Analysis of Feds Monetary Policy - Coursework Example

 The difference between the actual inflation rate and the ideal one is the inflation gap; the inflation gap rises during economic expansion and reduces in the recession period, and it is merely positive. The tradeoff between the output and inflation gap is always determined by the Fed’s objective function (Surico, 2007). However, Fed’s objective function looks at the aggressiveness of the policymakers. During the period of economic shock, the inflation rates or output levels in the economy are returned to their exact levels.

Besides, the economic model depicts that when output increases for a while, the unemployment level will reduce, and the inflation rate decreases over a certain time (Surico, 2007).Why didn’t policy based on the Phillips curve work to help the Fed reduce the unemployment rate to a lower level than before? What happened in the 1970s as the Fed tried to take advantage of the tradeoff between inflation and unemployment? The policy on Philip’s curve did not help Fed reduce the unemployment level to a lower level because the tradeoff between the higher level of unemployment and higher inflation is no longer there.

Therefore, there is a positive correlation between high inflation and high unemployment. In the 1970s, policymakers tried to take advantage of the tradeoff between unemployment and inflation rates, but it did not work either. However, this caused the expected inflation rate to rise; hence, the level of unemployment and inflation rose. Similarly, this also led to the short-run Philips curve shifting upwards.