Refer to the accompanying figure. An economy is currently in long-run equilibrium at point B, at an inflation rate of π', which is too high for to sustain economic growth. If an anti-inflationary policy is enacted, the economy will be in short-run equilibrium at point ________ creating ________ gap.
A)A; an expansionary
B)A; a recessionary
C)D; a recessionary
D)D; an expansionary

Question

Refer to the accompanying figure.  An economy is currently in long-run equilibrium at point B, at an inflation rate of π', which is too high for to sustain economic growth. If an anti-inflationary policy is enacted, the economy will be in short-run equilibrium at point ________ creating ________ gap.
A)A; an expansionary 
B)A; a recessionary 
C)D; a recessionary 
D)D; an expansionary

Quizplus · Accepted Answer

In order for policymakers to reduce inflation, they must tighten monetary policy by shifting its policy reaction function upward, which shifts aggregate demand left. This new short-run equilibrium will exist at point A, where the economy is experiencing a recessionary gap.

Refer to the Accompanying Figure