If individuals form rational expectations, an announced policy of reducing the rate of growth in the money supply that is credible will result in:
A) increased expectations of inflation.
B) unchanged expectations of inflation.
C) lower expectations of inflation.
D) possibly any of the above depending on the current inflation rate.

Question

Quizplus · Accepted Answer

If individuals form rational expectations, they will anticipate the government's monetary policy and adjust their behavior accordingly. If the government announces a credible policy of reducing the rate of growth in the money supply, individuals will adjust their expectations and anticipate lower inflation in the future. As a result, they may reduce their demand for goods and services, which will lead to lower prices and inflation. Thus, lower expectations of inflation is the most likely outcome.

If Individuals Form Rational Expectations, an Announced Policy of Reducing