According to the monetary policy rule, the central bank sets the nominal interest rate so that the real interest rate increases when inflation ____ its target, or output ____ its natural level.
A) rises above; rises above
B) rises above; falls below
C) falls below; falls below
D) falls below; rises above

Question

Quizplus · Accepted Answer

According to the monetary policy rule, when inflation rises above its target, the central bank will increase the nominal interest rate to make the real interest rate higher. This is intended to slow down economic growth and reduce inflation. Similarly, if output or real GDP rises above its natural level, the central bank will increase the interest rate to cool down the economy and bring output back to its potential level. Therefore, the correct choice is A, where the real interest rate increases when inflation rises above its target or output rises above its natural level.

According to the Monetary Policy Rule, the Central Bank Sets