Question

Suppose there is a downward surge in consumer confidence.

a) If the output gap is large and positive, the Fed should  (Click to select)  not change  lower  raise  the fed funds rate.

b) If the output gap is negative, the Fed should  (Click to select)  raise  not change  lower  the fed funds rate.

c) If the inflation rate is only 2 percent but accelerating per year, the Fed should  (Click to select)  lower  not change  raise  the fed funds rate.

Answer 1

If the output gap is positive it means there is an inflationary gap and the federal reserve should try to raise the federal funds rate in order to decrease the money supply and eliminate the inflationary gap

If the output gap is negative it means that there is a recessionary gap and the federal reserve should try to lower the federal funds rate in order to increase the money supply and eliminate the recessionary gap

the inflation rate is under the target but it is accelerating which means it will increase beyond the target. therefore the federal reserve should raise the federal fund rate to control it via money supply.