When there is an expansionary gap, inflation will ________, in response to which the Federal Reserve will ________ real interest rates, and output will ________.
A)decline; raise; decline
B)decline; lower; expand
C)decline; lower; decline
D)increase; raise; decline

Question

Quizplus · Accepted Answer

Increasing inflation rates eliminate expansionary gaps because the SRAS curve shifts upward to bring the economy back to long-term equilibrium. The Fed accommodates this shift by raising interest rates as inflation climbs according to its existing reaction function, which means that output decline to the level of potential output.

When There Is an Expansionary Gap, Inflation Will ________, in Response