If a negative aggregate demand shock occurs and monetary policy is not credible then ________.

Question

Quizplus · Accepted Answer

A negative aggregate demand shock can lead to decreased economic activity as firms reduce output and employment levels in response to lower demand. If monetary policy is not credible (i.e. the public does not believe that the central bank will be able to maintain low levels of inflation), then any attempts by the central bank to stimulate the economy through lower interest rates may not be effective. In fact, if the public expects that the central bank will allow inflation to rise in the long run, then the equilibrium interest rate may rise instead of falling, further dampening economic activity. However, there may not be a corresponding autonomous increase in inflation as this would depend on other factors such as the responsiveness of aggregate supply to changes in aggregate demand.

If a Negative Aggregate Demand Shock Occurs and Monetary Policy