If government purchases increase and as a result push current output above potential output, monetary policymakers are likely to:
A)Lower the real interest rate
B)Raise the real interest rate
C)Keep the real interest rate constant and focus on only changing the nominal interest rate
D)Purchase Treasury securities

Question

Quizplus · Accepted Answer

When government purchases increase and push current output above potential output, it leads to an increase in aggregate demand, causing prices to rise, and inflation to occur. To combat rising inflation, monetary policymakers are likely to raise the real interest rate, which reduces aggregate demand and helps to bring output back to its potential level. This is achieved by increasing the nominal interest rate, which in turn raises the real interest rate as inflation increases. Therefore, the best choice is B, which is to raise the real interest rate.

If Government Purchases Increase and as a Result Push Current