The Government And The Federal Reserve Bank Of America Essay

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In order to close the output gap, the Federal Government and The Federal Reserve Bank of America used monetary and fiscal policy to close gaps and have real measurements rise above potential. These policymakers often use potential output to gauge inflation and typically define it as the level of output consistent with no pressure for prices to rise or fall. In this context, the output gap is a summary indicator of the relative demand and supply components of economic activity. As such, the output gap measures the degree of inflation pressure in the economy and is an important link between the real side of the economy—which produces goods and services—and inflation. All else equal, if the actual output falls below potential output over time, prices will begin to fall to reflect weak demand.
For all central banks such as U.S. Federal Reserve, maintaining full employment is a policy target. Full employment relates to an output gap of zero. Nearly all central banks seek to keep inflation under control, and the output gap is a key determinant of inflation pressure on the economy, because the output gap gauges when the economy may be overheating or underperforming, it has immediate implications for monetary policy. Typically, during a recession, actual economic output drops below its potential, which creates a negative output gap. That below-potential functioning may spur a central bank to adopt a monetary policy designed to stimulate economic growth—by lowering interest rates,…

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