Which of the following statements best describes the Federal Reserve\'s conventi

Question

Which of the following statements best describes the Federal Reserve's conventional monetary policy?

A. If the economy grows too fast, resulting in a negative output gap, the Fed increases the money supply; and if the economy grows too slow, resulting in a positive output gap, the Fed decreases the money supply.

B. If the economy grows too slow, creating a negative output gap, the Fed increases the money supply; and if the economy grows too fast, creating a positive output gap, the Fed decreases the money supply.

C. If the economy grows too fast, resulting in a positive output gap, the Fed increases interest rates; and if the economy grows too slow, creating a negative output gap, the Fed decreases interest rates.

D. If the economy grows too fast, resulting in a negative output gap, the Fed increases interest rates; and if the economy grows too slow, creating a positive output gap, the Fed increases interest rates.

E. If the economy grows too fast, resulting in a positive output gap, the Fed increases the money supply; and if the economy grows too slow, creating a negative output gap, the Fed decreases the money supply.

A. If the economy grows too fast, resulting in a negative output gap, the Fed increases the money supply; and if the economy grows too slow, resulting in a positive output gap, the Fed decreases the money supply.

B. If the economy grows too slow, creating a negative output gap, the Fed increases the money supply; and if the economy grows too fast, creating a positive output gap, the Fed decreases the money supply.

C. If the economy grows too fast, resulting in a positive output gap, the Fed increases interest rates; and if the economy grows too slow, creating a negative output gap, the Fed decreases interest rates.

D. If the economy grows too fast, resulting in a negative output gap, the Fed increases interest rates; and if the economy grows too slow, creating a positive output gap, the Fed increases interest rates.

E. If the economy grows too fast, resulting in a positive output gap, the Fed increases the money supply; and if the economy grows too slow, creating a negative output gap, the Fed decreases the money supply.

Explanation / Answer

Correct option is (B).

When economy grows too slow, aggregate demand falls and there is a recessionary (negative output) gap, which can be closed by conventional expansionary monetary policy of increasing money supply to increase aggregate demand. In contrasts, when economy grows too fast, aggregate demand rises causing inflation and there is an inflationary (positive output) gap, which can be closed by conventional contractionary monetary policy of decreasing money supply to decrease aggregate demand.

(Note that a conventional monetary policy can be conducted by changing interest rate or using open market operations).

Related Questions

Navigate

• Browse (All)
• Browse W
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.