In the above figure, is the Fed likely to be afraid that ...

[tiffannnnyyyyyy]

In the above figure, is the Fed likely to be afraid that inflation will occur or that a recession will occur? Discuss the appropriate monetary policy that should be made to restore the economy to potential GDP.
 
  What will be an ideal response?

Question 2

When the macroeconomic equilibrium is such that real GDP is less than potential real GDP, the economy is suffering from ________, and the government policy to eliminate this gap will ________ real GDP and ________ the price level.
 
  A) a recessionary gap; decrease; decrease
  B) an inflationary gap; increase; decrease
  C) a recessionary gap; increase; increase
  D) an inflationary gap; decrease; increase
  E) a recessionary gap; decrease; increase

[stanleka1]

Answer to Question 1

The Fed will fear inflation. The economy is in a short-run equilibrium with real GDP of 13.5 trillion, which exceeds potential GDP of 13.0 trillion. If the Fed does nothing, the aggregate supply curve will begin to shift leftward, raising the price level and creating inflation as it moves the economy back to potential GDP. In order to limit the inflation, the Fed needs to raise the federal funds rate, thereby decreasing aggregate demand.

Answer to Question 2

C

[tiffannnnyyyyyy]

Gracias!

[momolu]

Excellent