Under the rational expectations hypothesis, which of the following is the most likely short-run effect of a move to expansionary monetary policy?
A) a higher general level of prices but little or no change in real output
B) a higher general level of prices and an expansion in real output
C) no change in the general level of prices and a reduction in real output
D) no change in either the general level of prices or real output

Question

Quizplus · Accepted Answer

Under the rational expectations hypothesis, individuals have accurate expectations about the future and adjust their behavior accordingly. If the central bank announces an expansionary monetary policy, individuals will expect higher inflation in the future, leading to an immediate increase in the general level of prices. However, as this increase in prices is expected, it will not lead to an increase in real output in the short-run. Therefore, choice A is the most likely short-run effect.

Under the Rational Expectations Hypothesis, Which of the Following Is