Suppose real and potential GDP are initially equal. If the Fed increases the target inflation rate, then in the long run we would expect
A)a higher real rate of interest.
B)lower real interest rates.
C)no change in the real rate of interest.
D)a decline in unemployment.
E)a decline in potential GDP.

Question

Quizplus · Accepted Answer

In the long run, an increase in the target inflation rate by the Federal Reserve is neutral with respect to the real rate of interest. According to the Fisher effect, nominal interest rates adjust to offset inflation, leaving the real interest rate unchanged. Additionally, long-term unemployment and potential GDP are primarily determined by real factors such as labor, technology, and resources, not by the inflation rate.

Suppose Real and Potential GDP Are Initially Equal