In the new classical model, an expansionary monetary policy will lead to a decline in aggregate output if ________.
A) the increase in money supply is less than anticipated
B) the increase in money supply is greater than anticipated
C) the increase in money supply comes as a surprise
D) the Bank of Canada announces the policy decision prior to its implementation

Question

Quizplus · Accepted Answer

In the new classical model, agents are rational and forward-looking. If they anticipate an expansionary monetary policy, they will adjust their expectations of future inflation and interest rates accordingly. This will lead to an increase in the demand for goods and services, which will offset the expansionary effects of the monetary policy. However, if the increase in money supply is less than anticipated, agents will be surprised and will not adjust their expectations. This will lead to a decline in aggregate output.

In the New Classical Model, an Expansionary Monetary Policy Will