The following graph summarizes the state of the economy. Your boss asks you how you think the Federal Reserve should respond to these economic conditions.

a. Would you recommend that the Fed try to increase, decrease, or not change the real interest rate? Explain your reasoning.

b. What type of shock will your policy change cause?

c. Which curve in the Fed model will shift?

d. Predict what will happen to real interest rates, output, and inflation.

Transcribed Image Text:

Real interest rate 2.5% Unexpected inflation 3% 1 I I MP curve I I IS curve 5% Output gap I Phillips curve 5% Output gap Worth Publishers