A decrease in interest rates by the Fed based on a given and unchanged policy reaction function represents a ________ the aggregate demand curve, and lower interest rates resulting from a downward shift in the Fed's policy reaction function represents a ________ the aggregate demand curve.
A)shift left of; movement up
B)shift left of; shift right of
C)movement up; movement down
D)movement down; shift right of

Question

Quizplus · Accepted Answer

For a fixed inflation rate target, a decrease in interest rates corresponds to a decrease in the inflation rate. A lower inflation rate is seen as a movement down the aggregate demand curve, as the rate of inflation is measured on the vertical axis when drawing aggregate demand. A downward shift in the Fed's policy reaction function means that the Fed is setting the real interest rate lower than before at each given rate of inflation. So each level of inflation now corresponds to a new higher level of output. Thus a downward shift of the Fed's policy reaction function makes the AD curve shift to the right.

A Decrease in Interest Rates by the Fed Based on a Given