If the principal instability in the economy is due to shifts in the IS curve,
A) targeting interest rates will do little or nothing to stabilize the magnitude of shocks to the economy.
B) targeting interest rates will stabilize the magnitude of shocks to the economy.
C) targeting the exchange rate will stabilize the magnitude of the shocks to the economy.
D) the Federal Reserve should take monetary policy action to shift the IS curve in the opposite direction of the shock.

Question

Quizplus · Accepted Answer

When the principal instability in the economy is due to shifts in the IS curve, targeting interest rates will do little or nothing to stabilize the magnitude of shocks to the economy because the IS curve represents the relationship between interest rates and the level of income that is in equilibrium in the goods market. Shifts in the IS curve are caused by changes in fiscal policy, consumer confidence, or investment, which are not directly controlled by interest rate targeting.

If the Principal Instability in the Economy Is Due to Shifts