If the Fed has a strong preference for stable prices relative to output, it responds to a price ________ with a ________ decrease in the interest rate.
A) increase; large
B) increase; small
C) decrease; large
D) decrease; small

Question

Quizplus · Accepted Answer

A decrease in prices (deflation) indicates a decrease in aggregate demand which can lead to a recession. To counteract this, the Fed typically decreases interest rates to stimulate lending and spending, which helps to increase aggregate demand and stabilize prices. A large decrease in interest rates may be necessary to have a significant impact on the economy during a deflationary period.

If the Fed Has a Strong Preference for Stable Prices