cheat sheet - The AD curve shows a negative relationship...

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The AD curve shows a negative relationship between two economic variables: real GDP and inflation. The relationship between the inflation rate and the real interest rate is called the monetary policy rule . When inflation rates rise, the Federal Reserve responds by raising the real interest rates (through a more than proportional increase in the nominal interest rate) and vice versa. Real Interest rate = Nominal Interest Rate minus the expected inflation rate. There is an inverse relationship between real GDP and inflation because an increase in inflation leads to a higher interest rate, which leads to a decrease in real GDP. Movements along the AD curve and shift of the AD curve: A change in real GDP due to a change in inflation is a movement along the aggregate demand curve. Shifts of AD curve can be caused by: Government Purchases (increase in government purchases shifts AD to the right). 2) Inflation Target Rate: A higher inflation target lowers interest rate. AD curve will shift right. A lower inflation target increases interest rate. AD curve will shift left. 3) An increase in net exports, consumption and decrease in taxes will lead to AD curve shifting right.
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