The aggregate demand curve shifts to the right when the Fed:
A)increases its target inflation rate, reflected by a downward shift in the Fed's policy reaction function.
B)decreases its target inflation rate, reflected by an upward shift in the Fed's policy reaction function.
C)increases real interest rates in response to inflation, but does not change its target inflation rate or the Fed's policy reaction function.
D)decreases real interest rates in response to inflation, but does not change its target inflation rate or the Fed's policy reaction function.

Question

Quizplus · Accepted Answer

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.

The Aggregate Demand Curve Shifts to the Right When the Fed