Suppose that the economy is producing above potential GDP and the Fed implements the correct change in monetary policy,but not until after the economy has passed the peak of the boom.Then
A)the Fed's contractionary policy will result in too large of a decrease in GDP.
B)the Fed's contractionary policy will result in too small of a decrease in GDP.
C)the Fed's expansionary policy will result in too small of a decrease in GDP.
D)the Fed's expansionary policy will result in too large of an increase in GDP.

Question

Quizplus · Accepted Answer

If the economy has already passed the peak of the boom and is producing above potential GDP, it is likely that inflationary pressures are already present. A correct change in monetary policy implemented by the Fed (i.e. contractionary policy) will aim to reduce inflationary pressures and bring the economy back towards its potential level of output. However, since the contractionary policy is implemented later than when it should have been implemented, the decrease in GDP may end up being larger than desired, as the economy may be more overheated than originally estimated. Therefore, Option A is the best choice.

Suppose That the Economy Is Producing Above Potential GDP and the Fed