Question

When current output is greater than potential output, which of the given monetary policies is the Federal Reserve (the Fed) likely to enact

Answer 1

When the current output is more than the potential output the fed is likely to enact decreasing reserves to increase interest rates.

The reason why they would have to do this is based on the fact that when the actual output in the economy is more than the potential output, It means that there is an inflationary gap.

In order to close this gap, the fed would have to reduce the aggregate demand, thereby raising the rate of interest. This would in turn lead to the fall in consumption and fall in saving.

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