Question

1) "Higher interest rates lower equilibrium real GDP and thus slow the rate of economic growth." Critique (and explain the underlying basis for) this quote noting whether it is true all of the time or only some of the time.

2)Typically, the Fed targets the fed funds rate. Assume that the Fed is operating the usual way, targeting a specific fed funds value (such as its present target), when the rate of economic growth begins to slow. Outline: (i) the actions the Fed would have to take to sustain its current interest rate target; (ii) the likely impact those actions will have on the rate of economic growth; and (iii) how the yield curve can be expected to change as a result of this event.

Answer 1

1).

Here we have given that higher interest rate decreases real GDP implied the slower the economic growth, this statement is only TRUE in the SR, because in the SR the AS is upward sloping, => if AD changes because of the change in interest rate causes real GDP changes implied the change in economic growth.

In the LR the real GDP is fixed at its potential level or at the full employment level, => any change in AD will not affect the real GDP, => in the LR the change in interest rate doesn’t have any effect on real GDP.