Suppose an economy exhibits a large unexpected decrease in productivity growth that lasts for a decade.However,monetary policymakers are slow to recognize that the change is to potential,not current,output and interpret the decrease in output as a recession that leads current output to fall below potential output.In this scenario,policymakers believe that recessionary pressures are building and incorrectly respond by increasing interest rates,sending the economy into a recessionary gap.

Question

Quizplus · Accepted Answer

If policymakers incorrectly interpret a decrease in productivity growth as a recession and respond by increasing interest rates, it would likely exacerbate the recessionary pressures, not create a recessionary gap. A recessionary gap occurs when actual output is below potential output, and raising interest rates would typically reduce demand further, worsening the gap.

Suppose an Economy Exhibits a Large Unexpected Decrease in Productivity