Assume that the economy is initially operating at the natural level of output. When the central bank raises the price target, the subsequent one- time 20% increase in the nominal money supply will cause:
A) a 20% increase in the interest rate in the medium run.
B) a 20% increase in output in the medium run.
C) a 20% increase in the real wage in the medium run.
D) a 20% increase in the price level in the medium run.
E) a 20% increase in the real money supply in the medium run.

Question

Quizplus · Accepted Answer

When the central bank raises the price target, the subsequent increase in nominal money supply will increase aggregate demand. This will lead to an increase in both output and price level (inflation) in the medium run. The increase in the nominal money supply will not directly affect the real wage or real money supply, and there is no clear relationship between the nominal money supply and interest rate in the short-run. Therefore, the correct answer is (D) a 20% increase in the price level in the medium run.

Assume That the Economy Is Initially Operating at the Natural