When the Federal Reserve increases its target rate of inflation, it will set a ________ real interest rate at every inflation rate and the aggregate demand curve will ________.
A)higher; shift to the right
B)lower; shift to the right
C)higher; shift to the left
D)lower; shift 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.

When the Federal Reserve Increases Its Target Rate of Inflation