A central bank can bring output back up to efficient level in the New Keynesian model by

Question

Quizplus · Accepted Answer

In the New Keynesian model, a central bank can stimulate aggregate demand by increasing the money supply, which reduces interest rates and increases consumption and investment spending. This, in turn, can bring output back up to its efficient level, known as potential output. Decreasing government expenses would actually decrease aggregate demand and further depress output. Increasing government expenses could potentially stimulate aggregate demand, but it would also increase the budget deficit, which could have negative long-term consequences for the economy. Therefore, the best choice is to increase the money supply.

A Central Bank Can Bring Output Back Up to Efficient