Given a monetary policy rule of the form r = p + 0.5Y^{^}+ 0.5p - p*) + 0.03, a negative aggregate demand shock resulting in a -5 percent GDP gap leads the Fed to A) lower nominal interest rates by 5 percent. B) lower the real interest rate target by 2.5 percent. C) lower nominal interest rates by 2.5 percent. D) lower the inflation target by 2.5 percent. E) wait and see if the shock turned out to be a permanent change.

Question

Quizplus · Accepted Answer

The Fed's policy rule implies that a -5 percent GDP gap would lead to a 2.5 percent decrease in the real interest rate target.

Given a Monetary Policy Rule of the Form R =