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

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An increase in real GDP above potential GDP indicates an overheated economy and an increase in inflationary pressures. To combat this, the Fed should raise the federal funds rate to increase the cost of borrowing and slow down spending in the economy. This should help bring down demand and move GDP back to its potential level. Lowering the federal funds rate (A) would only exacerbate the overheating problem by encouraging more borrowing and spending. Increasing the government's budget deficit (B) would also exacerbate the problem by increasing aggregate demand in the economy. Decreasing the government's budget deficit (C) might help in the long run but would not immediately address the overheating problem.

Consumer Confidence in the Economy Rises, and as a Result