Based on the given figure, the economy is initially at point A on the monetary policy reaction function (RF₁)and the aggregate demand curve (AD₁). The actual rate of inflation is π' and the Federal Reserve's target inflation rate is π*₁.

If the Federal Reserve raises its target inflation rate to π*₃, then the Federal Reserve's monetary policy reaction function will ________ and the aggregate demand curve will ________.
A)shift to RF₃; shift to AD₂
B)shift to RF₂; shift to AD₂
C)shift to RF₃; shift to AD₃
D)shift to RF₂; shift to AD₃

Question

Based on the given figure, the economy is initially at point A on the monetary policy reaction function (RF₁)and the aggregate demand curve (AD₁). The actual rate of inflation is π' and the Federal Reserve's target inflation rate is π*₁.  
  
If the Federal Reserve raises its target inflation rate to π*₃, then the Federal Reserve's monetary policy reaction function will ________ and the aggregate demand curve will ________.
A)shift to RF₃; shift to AD₂ 
B)shift to RF₂; shift to AD₂ 
C)shift to RF₃; shift to AD₃ 
D)shift to RF₂; shift to AD₃

Quizplus · Accepted Answer

A higher target inflation rate means easier monetary policy, which is seen as a downward shift in the Fed's policy reaction. At RF₃ the Fed is setting the real interest rate lower than before at each given rate of inflation. Aggregate expenditure and the short-run equilibrium output are increased at each rate of inflation as seen in the shift in AD curve from AD₁ to AD₂.

Based on the Given Figure, the Economy Is Initially at Point