Unlike an upward inflation shock,a negative shock to potential output causes
A) lower output and higher inflation.
B) higher output and lower inflation.
C) no output losses.
D) only temporary output losses.
E) permanent reduction in potential output.

Question

Quizplus · Accepted Answer

A negative shock to potential output refers to a persistent reduction in the economy's capacity to produce goods and services over the long run. Unlike a temporary output loss, a negative shock permanently lowers potential output, which means that the economy's maximum sustainable level of output has decreased. This results in a lower real GDP, higher unemployment, and lower inflationary pressures, as firms have less pricing power in a weaker demand environment. Therefore, option E is the correct answer.

Unlike an Upward Inflation Shock,a Negative Shock to Potential Output