Chapter 11, Problem 2CTQ

To determine

The reason as to why the Bank of Japan is being advised by economists to increase money supply subsequent to a consumption tax increase by the government.

Concept introduction:

Consumption Tax- Consumption tax is an indirect tax levied on consumer expenditure. The tax base is the money spent in the purchase of goods and services. The tax value is added to the cost of goods and services as sales tax or VAT etc. This tax burden results in a higher Maximum Retail Price (MRP) and is borne by the producers and consumers based on the elasticity of demand. Higher the elasticity of demand greater is the producers’ share in the tax and the more inelastic the demand, the consumers’ share of tax burden increases.

Expansionary and Contractionary Monetary policy- An expansionary monetary policy of the Federal Reserve implies employing the monetary tools at the disposal of the Fed like interest rate, CRR, SLR etc. to increase the money supply to stimulate the economy. The contractionary policy on the other hand is the use of these tools to decrease the money supply and thus slacken the economic activity in the country.