Suppose the central bank increases the money supply in an economy unexpectedly during a year.If the current inflation rate in this country is 3.4 percent, then according to new classical economists the expected inflation rate for the following year would be:
A)3.4 percent.
B)less than 3.4 percent.
C)2.4 percent, because people form their expectations adaptively.
D)around 6.8 percent.
E)greater than 3.4 percent.

Question

Quizplus · Accepted Answer

New classical economists believe that people form their expectations rationally, meaning they use all available information, including the unexpected increase in money supply, to predict future inflation. Therefore, they would expect a higher inflation rate than the current 3.4 percent.

Suppose the Central Bank Increases the Money Supply in an Economy