Figure 17-12

-Refer to Figure 17-12.In the dynamic AD-AS model,if the economy is at point A in year 1 and is expected to go to point B in year 2,the Federal Reserve would most likely
A) increase interest rates.
B) decrease interest rates.
C) not change interest rates.
D) increase the inflation rate.

Question

Figure 17-12
 
-Refer to Figure 17-12.In the dynamic AD-AS model,if the economy is at point A in year 1 and is expected to go to point B in year 2,the Federal Reserve would most likely
A) increase interest rates. 
B) decrease interest rates. 
C) not change interest rates. 
D) increase the inflation rate.

Quizplus · Accepted Answer

Point A in year 1 corresponds to an equilibrium output level below potential output, which implies a negative output gap. As the economy moves towards point B in year 2, the AD curve shifts to the right, and this could further exacerbate the output gap and put upward pressure on inflation. To prevent inflationary pressures from building up, the Federal Reserve would need to tighten monetary policy by raising interest rates, which would reduce aggregate demand and bring the economy closer to potential output. Therefore, the correct answer is A) Increase interest rates.

Figure 17-12 -Refer to Figure 17-12.In the Dynamic AD-AS Model,if the Economy