Question

Question 16

1. A negative aggregate demand shock affecting an economy that had been operating at potential output

   		a. Would require a tighter monetary policy if the shock were persistent
   		b. Would require a tighter policy if the shock were one-off and inflation expectations ratcheted upward
   		c. Would require no action by the central bank
   		d. Both a and b

Answer 1

A negative demand shock would shift the aggregate demand curve to the left means output would fall below potential output and price would fall. The government can use expansionary fiscal or monetary policy to close the recessionary gap but if the government did not intervene then the economy, in the long run, would self adjust to get back to the potential output because the wages would revise downwards and short-run aggregate supply would shift right and output would reach its potential but at a lower price level.

the correct option is c