In an economy where aggregate spending is given by Y = 5,500 + 0.6Y - 20,000r, the interest rate is currently 2 percent (0.02). If potential output equals 8,000, the central bank must ______ the interest rate to close the ______ gap.

Question

Quizplus · Accepted Answer

If potential output is 8,000, this economy has an expansionary gap. Y = 5,500 + 0.6(Y) - 20,000(0.02), so 0.4Y = 5,100 and Y = 12,750. This is an expansionary gap of 4,750 and interest rates must be raised to close the gap.

In an Economy Where Aggregate Spending Is Given by Y