Figure 11-4
-Refer to Figure 11-4. If the Fed acts to close the output gap in Panel (a), it would
A) sell government bonds which will lead to the shift in demand for bonds in Panel (b). This action will raise the price of bonds and lower the interest rate.
B) buy government bonds which will lead to the shift in demand for bonds in Panel (b). This action will raise the price of bonds and increase the interest rate.
C) buy government bonds which will lead to the shift in demand for bonds in Panel (b). This action will raise the price of bonds and lower the interest rate.
D) sell government bonds which will lead to the shift in demand for bonds in Panel (b). This action will raise the price of bonds and increase the interest rate.

Question

Figure 11-4 
-Refer to Figure 11-4. If the Fed acts to close the output gap in Panel (a), it would
A) sell government bonds which will lead to the shift in demand for bonds in Panel (b). This action will raise the price of bonds and lower the interest rate. 
B) buy government bonds which will lead to the shift in demand for bonds in Panel (b). This action will raise the price of bonds and increase the interest rate. 
C) buy government bonds which will lead to the shift in demand for bonds in Panel (b). This action will raise the price of bonds and lower the interest rate. 
D) sell government bonds which will lead to the shift in demand for bonds in Panel (b). This action will raise the price of bonds and increase the interest rate.

Quizplus · Accepted Answer

To close the output gap in Panel (a), the Fed would need to increase aggregate demand. This can be done by buying government bonds, which increases the money supply and lowers interest rates. As a result, the demand for bonds will shift to the right in Panel (b), raising the price of bonds and lowering the interest rate. Therefore, the correct choice is C.