Question

Consider an economy that abides by a Dynamic AS/AD model as presented in class, which, in period t-1, is in a short equilibrium that happens to coincide with a long run equilibrium. In period t there is a negative supply shock which dissipates in period t+1. There are two types of policy makers: hawks and doves. Which is true?

A. The size of the leftward shift of DAS in t+1 is less for Hawks than Doves

B. The size of the rightward shift of DAS in t+1 is greater for Hawks than Doves

C. The size of the rightward shift of DAS in t+1 is less for Hawks than Doves

D. The size of the leftward shift of DAS in t+1 is greater for Hawks than Doves

Answer 1

In period t-1, the AS curve shifts to the left, due to the negative supply shock.

In period t+1, the AS curve shifts to the right again, as the shock dissipates.

Now, this brings down the rate of inflation, and equilibrium is restored.

In general, Hawks will predict a higher rate of inflation in period t+1, and will thus advocate a strict monetary regime, while Doves favor more liberal regimes.

Hence, Hawks will feel that the rightward shift of the DAS has not been adequate enough to bring down prices. They will advocate tighter policy to control inflation.

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Thus the correct choice is:

C. The size of the rightward shift of DAS in t+1 is less for Hawks than Doves