Question

Assume that people form expectations rationally and that the sticky-price model describes the aggregate supply curve in the economy. For each of the following scenarios explain whether or not monetary policy can have real effects on the economy.

	A. The central bank determines monetary policy using the same information available to all firms and at the same time firms are setting prices, so that both firms and policymakers have all of the same information.
	B. The central bank determines monetary policy after firms have set prices using information not available at the time prices were set.

Answer 1

A) In this case there are no real effects because all the changes are already anticipated and incorporated by economci agents assuming that they are rational and form rational expectations. This happens because the available information is accessible and all monetary actions are already known.

B) Now that changes in monetray policy are made after the formation of rational expectations, the likely effects are mostly unanticipated so real variables are likely to be affected in the short run. Actual price level deviates from expected one and so real output deviations will also occur.