Suppose that the Federal Reserve is expected to expand the quantity of money by 5 percent but ends up expanding it by only 2 percent. If the new Keynesian theory is CORRECT, which of the following describes the effect on the economy?
A) The economy experience a boom because the quantity of money is still growing.
B) Inflation will be higher than expected.
C) Workers' decisions about when to work will be affected.
D) A recession will ensue.

Question

Quizplus · Accepted Answer

CAccording to New Keynesian theory, if the Federal Reserve expands the quantity of money by less than expected, it can lead to a recession because people and businesses were expecting more money in the economy, which affects spending and investment decisions. Additionally, workers' decisions about when to work will be affected because they base their decisions on expected inflation and real wages, which are impacted by the lower-than-expected expansion of the money supply.

Suppose That the Federal Reserve Is Expected to Expand the Quantity