Suppose that there is a negative aggregate supply shock and the central bank commits to an inflation rate target.

Question

Quizplus · Accepted Answer

A credible commitment to an inflation rate target means the public expects the central bank to do whatever it takes to keep inflation at the targeted rate, thus expected inflation remains unchanged (A). This credibility can help mitigate the negative effects of an aggregate supply shock by anchoring expectations, which can lead to better outcomes for both inflation and output in the short run (B). If the policy is not credible, the public may expect higher inflation, leading to worse economic outcomes, including a deeper contraction (C).

Suppose That There Is a Negative Aggregate Supply Shock and the Central