When current output is greater than potential output, which of the following mon

Question

When current output is greater than potential output, which of the following monetary policies is the Federal Reserve (the Fed) likely to enact? Making imports more costly to increase domestic spending. Increasing reserves to decrease interest rates. Decreasing reserves to increase interest rates. Stimulating consumer spending by manipulating tax rates. Which of the following is the most direct result of the correct monetary policy above? Increases in investment, aggregate demand, and long run growth. Decreases in sales of domestically-made goods. Increases in sales of domestically-made goods. Decreases in investment and a slowing of output growth.

Explanation / Answer

(1) Option (C)

When current output is greater than potential output, there is an inflationary gap which can be closed by decreasing aggregate demand. If Fed pursues a contractionary monetary policy by decreasing reserves to increase interest rte, higher interest rate will decrease investment demand which will lower aggregate demand, therefore lowering output back to potential output level.

(2) Option (D)

Hgher interest rate will decrease investment demand which will lower aggregate demand, therefore lowering output.

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