Suppose the economy is producing above potential GDP and the Federal Reserve implements the appropriate change in monetary policy, but not until after the economy has started to slow down on its own. In this situation there is a real danger that

A) the Fed's expansionary policy will result in too large of an increase in GDP. B) the Fed's contractionary policy will result in too large of a decrease in GDP. C) the Fed's contractionary policy will result in too small of a decrease in GDP. D) the Fed's expansionary policy will result in too small of an increase in GDP.

Question

Alana Beltran

Business

10 September, 16:41

Suppose the economy is producing above potential GDP and the Federal Reserve implements the appropriate change in monetary policy, but not until after the economy has started to slow down on its own. In this situation there is a real danger that

A) the Fed's expansionary policy will result in too large of an increase in GDP. B) the Fed's contractionary policy will result in too large of a decrease in GDP. C) the Fed's contractionary policy will result in too small of a decrease in GDP. D) the Fed's expansionary policy will result in too small of an increase in GDP.

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Answers (1)

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Ella Hooper · Answer 1

The correct answer is option b.

Explanation:

The economy operating above the potential level of GDP is facing inflationary pressures. The appropriate monetary policy in this situation is to adopt a contractionary monetary.

But if the fed is too late in adopting a contractionary policy and adopts one when the economy is already slowing down on its own, it may lead to an adverse effect on the economy.

The contractionary effect of the monetary policy can be more severe if the economy is slowing down. It can lead to a larger decrease in the GDP than necessary.