1) Suppose that inflation is currently 7% and inflationary expectations are also 7%. Assume that intermediate goods prices are not contributing to increased costs. If the Fed wishes to reduce inflation, it must set interest rates to ___________________.

A. raise investment

B. create an expansionary output gap

C. make actual output equal to potential output

D. create a recessionary output gap

E. raise consumption

2) If the Fed follows the Taylor Rule, it should raise the interest rate if inflation __________ or the expansionary gap __________ .

A. decreases; decreases

B. increases; increases

C. increases; decreases

D. decreases; increase

3) According to the Taylor rule, if there is a recessionary gap of 3 percent of potential output and inflation is 4 percent, what real interest rate will the Fed set?

A. 1.5 percent

B. 2 percent

C. 3 percent

D. 2.5 percent

Community Answer

Actual inflation = Expected inflation + Demand pull inflation + Cost (Supply) pull inflation   But in the given case:-   Actual inflation = Expected inflation   i.e. there is neither e ... See the full answer