Consider the Following Rule for Monetary Policy: R = 2

question 258

Multiple Choice

Consider the following rule for monetary policy: r = 2 percent +  + 1/2(y - y*) /y* + 1/2(- *) , where r is the nominal interest rate, y is real GDP, y* is an estimate of the natural rate of output, π is the inflation rate, and π* is the inflation target. Which of the following statements is not correct?

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

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Definitions:

Neutral Stimulus

A stimulus that initially produces no specific response other than focusing attention, until it is associated with an unconditioned stimulus.

Organism's Responding

The manner in which an organism reacts to stimuli or changes in its environment.

Conditioned Response

A learned reaction to a previously neutral stimulus that occurs as a result of conditioning, typically demonstrated in Pavlov’s dog experiment.

Unconditioned Response

A spontaneous, innate response to a trigger that happens without any previous training or conditioning.