If the economy is in a long-run equilibrium when the Federal Reserve decides that its inflation target is too low and chooses to raise it,________.
A)it would likely conduct an easing of monetary policy by lowering the real interest rate for any given inflation rate
B)an increase in aggregate demand would ensue generating a positive output gap
C)an eventual decrease in short-run AS would drive the long-run equilibrium level of inflation up
D)all of the above
E)none of the above

Question

Quizplus · Accepted Answer

When the Federal Reserve decides to raise its inflation target, it would likely ease monetary policy by lowering the real interest rate to stimulate the economy, leading to an increase in aggregate demand. This increase in demand can generate a positive output gap, where actual output exceeds potential output. Over time, this can lead to an increase in prices and wages as the economy adjusts, which would decrease short-run aggregate supply (AS) until a new long-run equilibrium is reached at a higher level of inflation. Thus, all of the given statements are correct in this context.

If the Economy Is in a Long-Run Equilibrium When the Federal