Suppose the Fed follows the Taylor rule.Which of the following is likely to happen if the Fed overestimates potential output?
A)The inflation rate will rise.
B)The federal funds rate will fall.
C)The money supply will decrease.
D)The income tax rates will increase.

Question

Suppose the Fed follows the Taylor rule.Which of the following is likely to happen if the Fed overestimates potential output​?
A)​The inflation rate will rise.
B)The federal funds rate will fall.​
C)​The money supply will decrease.
D)​The income tax rates will increase.

Quizplus · Accepted Answer

When the Fed overestimates potential output, it may set interest rates too low for the actual level of economic activity, leading to increased borrowing and spending, which can push inflation higher.

Suppose the Fed Follows the Taylor Rule