Suppose government purchases have decreased. Which of the following is true?
A)If inflation is lower in the new equilibrium, the Fed has allowed the target rate of inflation to drift up.
B)If inflation is constant in the new equilibrium, the Fed has decreased the target rate of inflation.
C)If inflation is lower in the new equilibrium, the Fed has allowed the target rate of inflation to drift down.
D)If inflation is lower in the new equilibrium, there has been no change in the target rate of inflation.
E)If inflation is constant in the new equilibrium, the Fed has increased the target rate of inflation.

Question

Quizplus · Accepted Answer

When government purchases decrease, this causes a decrease in aggregate demand, which leads to a lower equilibrium level of output and prices. If inflation is lower in the new equilibrium, this means that the Fed has allowed the target rate of inflation to drift down. This would be consistent with the Fed's goal of stabilizing the economy and keeping inflation near its target level. Choices A, B, D, and E are incorrect because they do not accurately reflect the relationship between changes in government purchases and inflation, or the Fed's response to these changes.

Suppose Government Purchases Have Decreased