If a point lies on the monetary policy reaction curve, and at this point the inflation rate equals the target rate of inflation, we know that:
A) the real interest rate corresponding to this point is above the long-run real interest rate.
B) the real interest rate corresponding to this point is equal to the long-run real interest rate.
C) the real interest rate corresponding to this point is below the long-run real interest rate.
D) current output is above potential output.

Question

Quizplus · Accepted Answer

The monetary policy reaction curve shows the relationship between the real interest rate chosen by the central bank and the inflation rate. If a point lies on the curve where inflation equals the target rate, it means the central bank has chosen the appropriate real interest rate to achieve this target. The long-run real interest rate is the rate that is consistent with potential output, and hence, it is the rate at which the economy can sustainably grow without generating inflationary pressure. Therefore, if the real interest rate corresponding to the point on the curve where inflation equals the target rate is the same as the long-run real interest rate, it implies that output is at potential and there is no output gap.

If a Point Lies on the Monetary Policy Reaction Curve