Consider the Following Rule for Monetary Policy: R = 2

question 76

Multiple Choice

Consider the following rule for monetary policy: r = 2 percent + p + 1/2(y - y*) /y* + 1/2(p - p*) ,where r is the nominal interest rate,y is real GDP,y* is an estimate of the natural rate of output,p is the inflation rate,and p* is the inflation target.What is the implication of this rule?

• A)If aggregate demand shifts right from long-run equilibrium, this rule unambiguously implies that the Bank of Canada decreases the nominal interest rate.
• B)If aggregate supply shifts right from long-run equilibrium, we cannot tell without more information whether the Bank of Canada should increase or decrease the nominal interest rate.
• C)If output is at its natural level but inflation is above its target, the Bank of Canada must decrease the nominal interest rate.
• D)If inflation is at its targeted level but output is above its natural rate, the Bank of Canada must decrease the federal funds rate.

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