An upward shift in the Fed's policy reaction function corresponds to a ________ the aggregate demand curve and an increase in exogenous spending corresponds to a ________ the aggregate demand curve.
A)shift left of; movement up
B)shift left of; shift right of
C)shift right of; shift left of
D)movement up; shift right of

Question

Quizplus · Accepted Answer

An upward shift in the Fed's policy reaction function means that the Fed is setting the real interest rate higher than before at each given rate of inflation. So each level of inflation now corresponds to a new lower level of output. Thus an upward shift of the Fed's policy reaction function makes the AD curve shift to the left. An increase in exogenous spending corresponds to a shift right of the aggregate demand curve, as this is a change in spending that is unrelated to output or the inflation rate (the only two variables measured in the AD graph).

An Upward Shift in the Fed's Policy Reaction Function Corresponds