Suppose that initially real GDP equals potential GDP. Then an increase in aggregate demand occurs. According to the Taylor rule, the Fed should ________ the federal funds rate by ________ government securities in the open market.
A) raise; selling
B) lower; selling
C) raise; buying
D) lower; buying

Question

Quizplus · Accepted Answer

When aggregate demand increases, it can lead to inflationary pressures. According to the Taylor rule, the Federal Reserve should respond by raising the federal funds rate to cool down the economy. The Fed raises the federal funds rate by selling government securities in the open market, which decreases the money supply and increases interest rates.

Suppose That Initially Real GDP Equals Potential GDP