Given an inflationary gap, the Federal Reserve will use monetary policy to _____ real GDP and _____ the interest rate.
A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease

Question

Quizplus · Accepted Answer

An inflationary gap occurs when the actual level of GDP is above the potential level of GDP, leading to an increase in prices and inflation. To address this, the Federal Reserve will use contractionary monetary policy to decrease the money supply, which will increase the cost of borrowing and increase the interest rate. This higher interest rate will reduce aggregate demand and ultimately decrease real GDP.

Given an Inflationary Gap, the Federal Reserve Will Use Monetary