Suppose that there is a positive aggregate demand shock and the central bank commits to an inflation rate target. If the commitment is credible, then ________.

Question

Quizplus · Accepted Answer

When a central bank commits to an inflation rate target and the commitment is credible, the public's expected inflation remains unchanged because they trust the central bank to take actions to maintain the inflation target. This trust means that the short-run aggregate supply curve does not shift in response to temporary deviations from the target, as suppliers and workers expect the central bank to correct any deviations. Over time, any inflation that deviates from the target due to the demand shock will fall back down to the inflation target as the central bank adjusts monetary policy to maintain its commitment. Therefore, all of the statements A, B, and C are correct, making D the correct choice.

Suppose That There Is a Positive Aggregate Demand Shock and the Central