In early in 1994, the Federal Reserve shifted to a contractionary policy although the economy Jwas still in a recessionary gap left over from the 1990-1991 recession. Which of the
Jfollowing best explains this move?
A) The Fed was concerned that the budget deficit would increase.
B) The Fed had failed to take into account the lag in monetary policy.
C) The Fed was taking explicit account of the lag in monetary policy.
D) The Fed wanted to avert a potential housing market crisis.

Question

Quizplus · Accepted Answer

The Fed's shift to a contractionary policy despite the economy being in a recessionary gap suggests that they were intentionally taking into account the lag in monetary policy. The lag refers to the delay between when a monetary policy action is taken and when it has an effect on the economy. Therefore, the Fed may have believed that it was necessary to begin scaling back on expansionary policies before the economy fully recovered to prevent inflation from spiraling out of control in the future.

In Early in 1994, the Federal Reserve Shifted to a Contractionary