If the Federal Reserve raises its target inflation rate, the monetary policy reaction function ________ and the aggregate demand curve ________.
A)shifts upward to the left; shifts to the right
B)shifts downward to the right; shifts to the right
C)shifts upward to the left; shifts to the left
D)shifts downward to the right; shifts to the left

Question

Quizplus · Accepted Answer

A higher target inflation rate means an easing of monetary policy, which is seen as a downward shift in the Fed's policy reaction. With the Fed setting the real interest rate lower than before at each given rate of inflation, aggregate expenditure and the short-run equilibrium output is increased at each rate of inflation. Alternatively, we can say that each level of inflation now corresponds to a new higher level of output. Thus a downward shift of the Fed's policy reaction function shifts the AD curve to the right.

If the Federal Reserve Raises Its Target Inflation Rate, the Monetary