question archive If the current situation of a country is: Real GDP=$11
Subject:EconomicsPrice:2.88 Bought3
If the current situation of a country is:
Real GDP=$11.1 trillion
Inflation rate=3.1%
and it needs to be:
Real potential GDP=$10.6 trillion
Target (or desired) inflation rate=2.5%,
what should be done in terms of its open market operations to bring economy toward full employment?
We first need to identify the kind of output gap in the economy. Since the current real GDP in this economy is higher than the potential level of output, there is a inflationary gap. This is also reflected in the fact that current inflation is higher than the desired level of inflation.
To reduce inflation, the central bank should conduct contractionary monetary policy. This involves selling government securities in the open market, and retract liquidity from the market to raise interest rate.