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

Question

Quizplus · Accepted Answer

According to the rational expectations hypothesis, individuals have rational expectations about future events including the effects of monetary policy. Therefore, if the central bank announces a more expansionary monetary policy, individuals will anticipate higher inflation in the future leading to an immediate increase in prices. However, in the long run, the expansionary policy may not have any effect on real output because output is determined by factors other than monetary policy such as technology, labor force, and capital stock.

Under the Rational Expectations Hypothesis, Which of the Following Is