Analyze the following statement, and show what would happen in the long run if such advice were followed by the Fed: "The increase in the stock market has increased people's wealth

As a result, their consumption has increased, increasing aggregate demand and output. So the Fed needs to increase the money supply, since with higher income, people's demand for real money balances will be higher."

Assuming resources are fully utilized, there will be no increase in output. Higher wealth will reduce saving, shifting the IS curve up and to the right. Increasing the money supply shifts the LM curve down and to the right. But general equilibrium will require the LM curve to shift up and to the left. So the price level must rise, and it rises even more because of the monetary policy suggested by the statement. The correct monetary policy for preventing inflation is to reduce, not increase, the money supply.