Suppose that the economy is in long-run equilibrium and the government decided to engage in unexpected contractionary policy by decreasing the money supply. If we assume rational expectations, which of the following statements is correct about the effect of contractionary policy in the long run?

Question

Quizplus · Accepted Answer

In the long run, the economy will adjust to the decrease in the money supply by decreasing the price level and the level of real GDP will remain unchanged due to the classical dichotomy. The unemployment rate will also remain unchanged in the long run as there is no long-run trade-off between inflation and unemployment according to the natural rate hypothesis. Therefore, option D is the correct answer.

Suppose That the Economy Is in Long-Run Equilibrium and the Government