Assume that there is a short-run tradeoff between inflation and unemployment, that the central bank desires both low inflation and low unemployment, and that the central bank uses discretion in conducting monetary policy. Initially, households and firms expect high inflation. Following an announcement by the central bank of a low-inflation policy, households and firms will ______ the central bank's announcement and ______ their expectations of inflation.
A) believe; lower
B) not believe; not change
C) believe; not change
D) not believe; lower

Question

Quizplus · Accepted Answer

Given the context of discretion in monetary policy and an initial expectation of high inflation, households and firms are likely to doubt the central bank's commitment to a low-inflation policy. This skepticism stems from the central bank's past behavior or the lack of a credible commitment mechanism, leading them to maintain their high inflation expectations.

Assume That There Is a Short-Run Tradeoff Between Inflation and Unemployment