Question 6

In 1997, East Asian economies faced a major financial crisis, which reduced their incomes and their demands for US exports. Suppose the Fed believed that the negative impact of the crisis on the US economy would be sizable and would take a few years. Assume that before the crisis, the US economy was on its long-run equilibrium path. In that case, if the Fed wanted to stabilize the level of income and inflation in the US for the duration of the adverse demand shock, what should it have done?

a. Nothing the economy would have quickly adjusted to the shock and returned to stability by itself.

b. The Fed should have reduced money supply

c. The Fed should have have waited a couple of years to assess the situation better before acting.

d. The Fed should have increased money supply.