Assume the economy is in short-run equilibrium at a real GDP above its potential real GDP. According to classical theory, which of the following policies should be followed?
A) The Federal Reserve should use open market operations and buy U.S. government securities.
B) The Federal Reserve should not follow a fixed rule.
C) The federal government should cut taxes.
D) Fiscal policy and monetary policy should not be activist.

Question

​ Assume the economy is in short-run equilibrium at a real GDP above its potential real GDP. According to classical theory, which of the following policies should be followed?
A) ​The Federal Reserve should use open market operations and buy U.S. government securities.
B) ​The Federal Reserve should not follow a fixed rule.
C) ​The federal government should cut taxes.
D) ​Fiscal policy and monetary policy should not be activist.

Quizplus · Accepted Answer

Classical theory suggests that the economy will self-correct in the long-run and return to its potential real GDP. In the short-run, the economy may experience inflationary pressures due to the excess demand in the economy. However, the classical economists believed that any government intervention to correct this would only worsen the situation in the long-run. Therefore, according to the classical theory, fiscal policy and monetary policy should not be activist, and the government should instead adopt a laissez-faire approach. As a result, the best choice is D.

​ Assume the Economy Is in Short-Run Equilibrium at a Real

Assume the Economy Is in Short-Run Equilibrium at a Real