Consider the following table: What can we expect from the Federal Reserve Bank i
ID: 1213041 • Letter: C
Question
Consider the following table: What can we expect from the Federal Reserve Bank if it seeks to move the economy in the direction of long-run macroeconomic equilibrium? A The Fed will pursue a contractionary fiscal policy. The Fed will pursue an expansionary fiscal policy. The Fed will pursue a contractionary monetary policy. The Fed will pursue an expansionary monetary policy. If the Fed's policy is successful, what is the effect on the following indicators? Actual real GDP: Potential real GDP: Price level: UnemploymentExplanation / Answer
(1) (C)
In long run equilibrium, potential GDP = Real GDP
In 2015, real GDP > Potential GDP creating an expansionary gap. To bring back the economy to equilibrium, real GDP has to be lower. This can be done by lowering aggregate demand with Fed pursuing contractionary monetary policy.
(2) If contractionary policy is successful, then
- Actual real GDP: DECREASES
- Potential real GDP: NO CHANGE
- Price level: DECREASES (Since aggregate demand falls)
- Unemployment: INCREASES (Since aggregate demand falls)