Suppose an economy exhibits a large unexpected decrease 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 decrease in output as a recession that leads current output to fall below potential output. In this scenario, policymakers believe that recessionary pressures are building and incorrectly respond by increasing interest rates, sending the economy into a recessionary gap.

Question

Quizplus · Accepted Answer

In this scenario, if policymakers mistakenly interpret the decrease in output as a recession, they would likely respond by lowering interest rates to stimulate the economy, not increasing them. Increasing interest rates would be the response to an overheating economy, not one perceived to be in a recession.

Suppose an Economy Exhibits a Large Unexpected Decrease in Productivity