Question

13) Suppose that there is a positive aggregate demand shock and the central bank commits to an inflation rate target. If the commitment is credible, then A) the short-run aggregate supply curve will not shift. B) the public's expected inflation will remain unchanged. C) over time inflation will fall back down to the inflation target. D) all of the above. E) both A and B.

Answer 1

Answer:

C) over time inflation will fall back down to the inflation target.

Explanation:

In the scenario, there is a positive aggregate demand shock which will lead to inflation because prices of goods will rise as aggregate demand increases with supply being unchanged

A demand shock is a sudden event that increases or decreases demand for goods or services temporarily. A positive demand shock increases aggregate demand and a negative demand shock decreases aggregate demand.

Therefore there will be an initial inflation with the shock but since demand shocks are temporary and the central bank commits to an inflation rate target, then over time inflation will fall back down to the inflation target.