If the Federal Reserve chooses to fight high inflation with contractionary monetary policy and firms and consumers expect this policy to reduce inflation,which of the following would you expect to see?

Question

Quizplus · Accepted Answer

With contractionary monetary policy, the Fed reduces the money supply and raises interest rates, which leads to reduced spending and investment. As a result, firms and consumers expect lower inflation, causing a downward shift of the short-run Phillips curve. This shift indicates that the same level of inflation is achievable with a higher level of unemployment. Thus, the Fed's policy reduces inflation at the expense of higher unemployment in the short run. However, the reduction in inflation expectations may also ease inflationary pressure in the long run. A decrease in the long-run aggregate supply curve indicates reduced productive capacity and higher costs, which are unlikely to happen due to monetary policy alone. An increase in inflationary expectations would be counterproductive to the Fed's goal of reducing inflation.

If the Federal Reserve Chooses to Fight High Inflation with Contractionary