With rational expectations, a policy that would increase AD would lead to:
A)higher inflation and higher real output in the short run.
B)higher inflation and lower real output in the short run.
C)higher inflation and an indeterminate effect on real output in the short run, if people's expectations were correct.
D)higher inflation and no change in real output, if people's expectations were correct in the short-run.

Question

With rational expectations, a policy that would increase AD would lead to:
A)​higher inflation and higher real output in the short run.
B)​higher inflation and lower real output in the short run.
C)​higher inflation and an indeterminate effect on real output in the short run, if people's expectations were correct.
D)​higher inflation and no change in real output, if people's expectations were correct in the short-run.

Quizplus · Accepted Answer

Rational expectations suggest that individuals will anticipate the effects of monetary policy on inflation. If they correctly anticipate an increase in aggregate demand (AD) due to policy actions, they will adjust their behavior in advance, leading to higher inflation but no change in real output in the short run, as any potential increase in output would be offset by the adjustments in expectations and behavior.

With Rational Expectations, a Policy That Would Increase AD Would