Question

If potential output equals 3,000 and short-run equilibrium output equals 3,500, there is a(n) ______ gap and the Federal Reserve must _____ real interest rates in order to close the gap.

A. recessionary; raise B. recessionary; lower C. recessionary; not change D. expansionary; raise

Answer 1

D. expansionary; raise

Step-by-step explanation:

In order to maintain the equilibrium, in this case,

The Federal Reserve will opt for expansionary monetary policies, under which the real interest rates will be increased by the Federal Reserve.

As the output is less than the equilibrium output, by increasing the real interest rates, the equilibrium can be achieved.