When an output gap exists, ﬁscal or monetary policy should be neutral.

Question

Quizplus · Accepted Answer

When an output gap exists, fiscal or monetary policy should be used to address it. Fiscal policy can be expansionary by increasing government spending or reducing taxes, while monetary policy can be accommodative by lowering interest rates or increasing the money supply. The idea is to close the output gap and return the economy to its potential level of output. Neutral policy would not address the output gap and could potentially prolong the downturn or exacerbate inflationary pressures.

When an Output Gap Exists, ﬁScal or Monetary Policy Should