Starting from the natural level of output, an unexpected monetary contraction will cause output and the price level to ______ in the short run; and in the long run the expected price level will ______, causing the level of output to return to the natural level.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase

Question

Quizplus · Accepted Answer

An unexpected monetary contraction will lead to a decrease in the money supply and an increase in interest rates. This will cause a decrease in consumer and investment spending, and hence a decrease in aggregate demand. As a result, output and the price level will also decrease in the short run. In the long run, however, the expected price level will also decrease due to the decrease in aggregate demand, causing the level of output to ultimately return to the natural level. Hence, option C is the correct choice.

Starting from the Natural Level of Output, an Unexpected Monetary