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

Question

Quizplus · Accepted Answer

When inflation is above its target, the central bank increases the nominal interest rate to reduce demand and cool down the economy, which in turn raises the real interest rate (nominal interest rate minus inflation rate). Similarly, when output is below its natural level, the central bank cuts the nominal interest rate to stimulate demand and boost the economy, which in turn lowers the real interest rate. Therefore, the real interest rate rises when inflation is high and falls when output is low.

According to the Monetary Policy Rule, the Central Bank Sets