For a fixed target real interest rate and target inflation rate, when inflation increases, the Fed ________ interest rates, hence ________ short-run equilibrium output.
A)increases; increasing
B)decreases; increasing
C)increases; decreasing
D)decreases; decreasing

Question

Quizplus · Accepted Answer

When the inflation rate increases, the Fed responds by raising the real interest rate per its reaction function. This increase in the real interest rate reduces consumption and investment, thereby decreasing the short-run equilibrium output.

For a Fixed Target Real Interest Rate and Target Inflation