In an economy where planned aggregate spending is given by PAE = 3,000 + .75Y − 10,000r, the central bank is currently setting the interest rate at 0.05 (5 percent). If potential output equals 10,800, the central bank must ________ the interest rate to close the ________ gap.
A)lower; recessionary
B)raise; recessionary
C)lower; expansionary
D)raise; expansionary

Question

In an economy where planned aggregate spending is given by PAE = 3,000 + .75Y − 10,000r, the central bank is currently setting the interest rate at 0.05 (5 percent). If potential output equals 10,800, the central bank must ________ the interest rate to close the ________ gap.
A)lower; recessionary
B)raise; recessionary
C)lower; expansionary
D)raise; expansionary

Quizplus · Accepted Answer

If potential output is 10,800, this economy has a recessionary gap. PAE = 3,000 + 0.75(Y)− 10,000(0.05), so 0.25Y = 2,500 and Y = 10,000. This is a recessionary gap of 800 and interest rates must be lowered to close the gap.

In an Economy Where Planned Aggregate Spending Is Given by PAE