Consumer confidence in the economy rises, and as a result, real GDP increases above potential GDP. To move U.S. GDP back to potential GDP, the Fed should

Question

Quizplus · Accepted Answer

When real GDP increases above potential GDP, there is a risk of inflationary pressures. To address this risk, the Fed should raise the federal funds rate, which will increase borrowing costs, reduce consumption and investment spending, and slow down the pace of economic growth, bringing GDP back to potential level. Lowering the federal funds rate or increasing the government's budget deficit would have the opposite effect and further stimulate the economy, worsening the inflationary pressure. Decreasing the government's budget deficit, while necessary for long-term fiscal stability, would not directly address the short-term issue of inflationary pressure.

Consumer Confidence in the Economy Rises, and as a Result