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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