Suppose the economy is growing faster than its long-run potential growth rate.To bring the real growth rate back to the long-run potential rate,the Fed should:
A) lower the required reserve ratio.
B) buy government bonds in the open market.
C) raise the discount rate.
D) lower the interest rate on reserves.

Question

Quizplus · Accepted Answer

To bring the real growth rate back to the long-run potential rate, the Fed should implement contractionary monetary policy, which would increase interest rates and reduce spending. One way to do this is by raising the discount rate, which would increase the cost of borrowing for banks and discourage lending, thereby reducing spending and bringing the economy back to its long-run potential growth rate. Lowering the required reserve ratio or lowering the interest rate on reserves would stimulate lending and increase spending, which would exacerbate the problem of the economy growing faster than its long-run potential growth rate. Buying government bonds in the open market is a tool used for expansionary monetary policy, which is not appropriate in this scenario.

Suppose the Economy Is Growing Faster Than Its Long-Run Potential