Question

When there is an expansionary gap, inflation will ______, in response to which the Federal Reserve will ____ real interest rates, and output will _____.

Answer 1

Answer: increase; raise; decline

Explanation:

An expansionary gap occurs in an economy when the potential output in the economy is less than the actual output.

It should be noted that when there is an expansionary gap, this will lead to a rise in inflation. Since inflation has risen, the government will also increase the real interest rates which will in turn, lead to the reduction in output.