In an economy where planned aggregate spending is given by PAE = 5,500 + 0.6Y − 20,000r, the interest rate is currently 5 percent (0.05). If potential output equals 11,750, the central bank must ________ the interest rate to close the ________ gap.
A)reduce; expansionary
B)reduce; recessionary
C)raise; recessionary
D)raise; expansionary

Question

Quizplus · Accepted Answer

If potential output is 11,750, this economy has a recessionary gap. PAE = 5,500 + 0.6(Y)− 20,000(0.05), so 0.4Y = 4,500 and Y = 11,250. This is a recessionary gap of 500 and interest rates must be reduced to close the gap.

In an Economy Where Planned Aggregate Spending Is Given by PAE