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# Fed policy for maintaining real GDP at its potential

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The information below shows the situation in 2010 and 2011 if Fed does not use the monetary policy:

Year Potential Real GDP Real GDP Price Level
2010 \$14 trillion \$14 trillion 120
2011 \$15 trillion \$15.2 trillion 133

a) If Fed wants to keep real GDP at its potential level in 2011 should it use expansionary policy  or a contractionary policy?  Should Fed NY sell or buy Tâ?bills?  How about Fed Dallas and Fed Philadelphia, are they expected to sell or buy Tâ?bills?

b) If the Fedâ??s policy in keeping real GDP at its potential in 2011, state whether each of the  following will be higher, lower, or the same as it would have been if the Fed had taken no action:
1. Real  GDP;
2. Potential  GDP;
3. The  inflation  rate;
4. The  unemployment  rate

c) Draw an aggregate demand and aggregate supply  graph to illustrate your answer.   Be sure that your graph contains LRAS curves for 2010 and 2011; SRAS curves for 2010 and 2011;  AD curves for 2010 and 2011, with and without monetary policy action; and equilibrium real GDP and price level in 2011 with and without policy.

https://brainmass.com/economics/unemployment/fed-policy-for-maintaining-real-gdp-at-its-potential-368235

#### Solution Preview

Notice that potential real GDP is lower than real GDP in 2011. This means that the Fed needs to slow down the economy, or use contractionary monetary policy. It will need to sell T bills, which reduces currency in circulation. All branches of the Fed ...

#### Solution Summary

The Fed's response to changes in real GDP

\$2.19

## Suppose the tax rate on interest income is 25 percent, the real interest rate is 4 percent, and the inflation rate is 4 percent.

* 1. Suppose the tax rate on interest income is 25 percent, the real interest rate is 4 percent, and the inflation rate is 4 percent. In this case, the real after-tax interest rate is
a. .5%
b. 3.5%
c. 4.0%
d. 2.0%

* 2. With a steep short-run aggregate supply curve,
a. an increase in government spending will not have an impact on the price level.
b. fiscal policy will be an effective tool to reduce unemployment without raising prices too much.
c. an increase in taxes that does not change potential GDP will not decrease real GDP by much.
d. there is a large change in real GDP whenever the price level rises.

* 3. Monetary policy affects macroeconomics performance by
a. changing aggregate supply.
b. creating budget surpluses.
c. changing aggregate demand.
d. creating budget deficits.

* 4. Suppose that the Fed is using this feedback rule: Every time real GDP exceeds potential GDP, contractionary policy is used and whenever real GDP is less than potential GDP, expansionary policy is used. GDP equals potential GDP and then aggregate demand increases. As a consequence of the policy action taken the resulting
a. contractionary policy will lower the price level from what it otherwise would be.
b. contractionary policy will decrease unemployment from what it otherwise would be.
c. expansionary policy will decrease unemployment from what it otherwise would be.
d. expansionary policy will lower the price level from what it otherwise would be.

* 5. The Taylor Rule is an example of
a. a feedback-rule policy.
b. discretionary monetary policy.
c. a fixed rule.
d. an activist rule

* 6. Country A and country B both consume and produce only food and clothing. Both countries use only labor to produce these two products. A worker in country A can produce 6 units of clothing or 10 units of food each day while a worker in country B can produce 4 units of clothing or 8 units of food. Which of the following statements is true?
a. The opportunity cost of clothing production in country A is greater than that of country B.
b. The opportunity cost of food production in country A is greater than that of country B.
c. The opportunity cost of food production in country A is the same as that of country B.
d. The opportunity cost of clothing production in country B is less than that of country A.

* 7. Suppose the target exchange rate set by the Fed is 150 yen per dollar. If the demand for dollars permanently decreases the Fed
a. can permanently meet the target by selling dollars.
b. can permanently meet the target by buying dollars.
c. must violate both interest rate parity and purchasing power parity to permanently meet the target.
d. cannot permanently maintain the target rate.

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