Suppose the Canadian economy is operating at potential output. A negative supply shock that is accommodated by an open market purchase by the Bank of Canada will cause ________ in real GDP in the long run and ________ in the aggregate price level in the long run, everything else held constant.
A) no change; an increase
B) no change; a decrease
C) an increase; an increase
D) a decrease; a decrease

Question

Quizplus · Accepted Answer

A negative supply shock typically reduces output and increases prices. If the Bank of Canada accommodates this shock with an open market purchase (buying securities to inject money into the economy), it will not affect the long-run real GDP (which returns to potential output), but it will lead to higher prices in the long run due to the increase in the money supply.

Suppose the Canadian Economy Is Operating at Potential Output