In the Basic New Keynesian model, if the central bank is initially achieving its goals, and the natural rate of interest rises, the central bank should

Question

Quizplus · Accepted Answer

In the Basic New Keynesian model, if the natural rate of interest rises, it implies that the equilibrium real interest rate also increases. If the central bank continues with the same nominal interest rate, it will lead to a situation of excess demand for goods and services, which will eventually lead to an increase in prices. To prevent this inflationary pressure, the central bank should increase the nominal interest rate, but not by the same amount as the natural real interest rate increase, to keep the economy at full employment and stable prices. Therefore, the correct choice is E, which states that the central bank should increase the nominal interest rate by less than the amount of the natural real interest rate increase.

In the Basic New Keynesian Model, If the Central Bank