For a fixed target real interest rate and target inflation rate, when inflation decreases, 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 decreases, the Fed responds by lowering the real interest rate per its reaction function. This decrease in the real interest rate increases consumption and investment, thereby increasing the short-run equilibrium output.

For a Fixed Target Real Interest Rate and Target Inflation