Suppose the economy is currently at potential output and the inflation rate is 8%.
Suppose the federal funds rate is currently 3%
a. The board of governors meets to set a new target federal funds rate. Would you expect it to be 2% or 4%?
b. How would you expect the Fed to reach the new target?
c. What impact would this have on the price level and real GDP in the SR and LR (use the AD/AS model).
Answer a: The new federal funds rate would be 4%. The inflation is 8% (which is extremely high). Controlling inflation is the primary goal of the Fed. Thus to bring inflation under control, the Fed would be more ...
The solution explains how the Fed usually controls the Federal Funds Rate.