Beginning at long-run equilibrium in the dynamic model of aggregate demand and aggregate supply, in the periods after a permanent reduction in the central bank's inflation target, the DAS shifts downward because:
A) the natural level of output increases in response to the lower rates of inflation.
B) the deviation of output from the natural level of output increases as a result of lower rates of inflation.
C) lower rates of inflation generate negative supply shocks.
D) expectations of inflation decrease as a result of lower inflation in previous periods.

Question

Quizplus · Accepted Answer

Expectations of inflation decrease as a result of lower inflation in previous periods, leading to a downward shift in the Dynamic Aggregate Supply (DAS) curve. This is because the central bank's actions to reduce the inflation target influence people's expectations about future inflation, which in turn affects wage-setting and price-setting behavior, aligning with lower inflation expectations.

Beginning at Long-Run Equilibrium in the Dynamic Model of Aggregate