The graph above shows a central bank targeting an interest rate i_T. This policy is said to be destabilizing since the change in output from _____ is greater than the change in output from A) A to B, B to C. B) A to C, A to B. C) A to C, B to C. D) none of the above.

Question

Quizplus · Accepted Answer

From point A to point C, the central bank increases the interest rate from iS1U1B1 to iS1U1B0 and output falls from Y1 to Y2, a relatively large decrease. In contrast, from point B to point C, the central bank only makes a small increase in interest rates from iS1U1B0 to iS1U0B0 and output falls from Y2 to Y3, a relatively smaller decrease. Therefore, the change in output from A to C is greater than the change in output from B to C, making the policy destabilizing.

The Graph Above Shows a Central Bank Targeting an Interest