Suppose an economy exhibits a large unexpected increase 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 they interpret the increase in output as a boom that leads current to exceed potential output. In this scenario, policymakers believe that ________ pressures are building and incorrectly respond by ________ interest rates, sending the economy into a(n) ________ gap.
A) inflationary; raising; recessionary
B) inflationary; reducing; recessionary
C) recessionary; raising; expansionary
D) recessionary; reducing; recessionary
E) Not enough information is given.

Question

Quizplus · Accepted Answer

Policymakers misinterpret the productivity growth as a sign of an overheating economy, fearing inflation, so they raise interest rates to cool it down, which can unnecessarily slow the economy and create a recessionary gap.

Suppose an Economy Exhibits a Large Unexpected Increase in Productivity