If the economy is in a long-run equilibrium when the Federal Reserve decides that its inflation target is too low and chooses to raise it,________.
A)monetary policy would ultimately lead to higher potential output but real interest rates and inflation would be unaffected in the long run
B)monetary policy would ultimately lead to higher inflation but real interest rates and potential output would be unaffected in the long run
C)monetary policy would ultimately lead to higher interest rates but potential output and inflation would be unaffected in the long run
D)monetary policy would ultimately lead to higher interest rates,potential output,and inflation in the long run
E)none of the above

Question

Quizplus · Accepted Answer

In the long run, potential output is determined by factors such as labor force, technology, and capital stock. Changes in monetary policy cannot affect these factors, so potential output would be unaffected. However, if the Fed raises its inflation target, this would lead to higher inflation in the long run as prices adjust to the new target. Meanwhile, real interest rates (i.e. interest rates adjusted for inflation) would be unaffected since the increase in inflation expectations would be offset by the increase in the Fed's target. Therefore, Choice B is the best answer.

If the Economy Is in a Long-Run Equilibrium When the Federal