Assuming adaptive expectations,a "cold turkey" reduction in AD by policymakers will initially reduce
A)output but not inflation.
B)inflation but not output.
C)output less than inflation.
D)both output and inflation.

Question

Quizplus · Accepted Answer

Assuming adaptive expectations, a sudden reduction in aggregate demand by policymakers would lead to a decrease in output and an increase in inflation. This is because firms and households would initially expect the previous level of aggregate demand to continue, and since the sudden reduction in demand would be unexpected, firms would produce more than they could sell, leading to a decrease in output, and this would increase the prices of goods and services, leading to inflation.

Assuming Adaptive Expectations,a "Cold Turkey" Reduction in AD by Policymakers