Question

Briefly describe the institutionalist theory of inflation as compared to the quantity theory of inflation?

According to the institutional theory, how does the price-setting process contribute to inflation?

Discuss how the federal reserve if put in a position of increasing the money supply or possibly forcing a recession?

Answer 1

Part A

We know that the institutionalist theory is different from the quantity theory of inflation is the sense that, it determines how the firms determine the wages and prices. It concentrates on the institutionalist price setting behavior.

Part B

In the institutional process, the individual set the price according to their institutional incentives. That means this incentive completely removed the aggregate employment process. Moreover, it leads to inflation because of the lack of coordination between individual nominal wages and price decisions.

Part C

At the time of recession, the Fed wants to increase the aggregate demand by increasing the money supply. According to the liquidity preference theory, increasing the money supply will reduce the interest rate, and it increase in the investment. As a result, it will increase aggregate demand.