Question

Say whether you think the statement is true, false, or uncertain; and support your answer in a few lines. 1. Consider two similar economies hit by the same temporary negative supply shock. In the economy with the more credible monetary policy, there will be smaller increases in both inflation and the real interest rate. 2. If the public believes the commitment to a nominal anchor to be credible, the effect of a negative aggregate demand shock is for short-run aggregate supply to be unaffected.

Answer 1

1. true, in case of negative supply shock, real gdp reduces and price level rise. increase in price level is often associated with increase in rate of interest that discourages investment causing gdp to fall. if there is credible monetary policy it will maintain the initial interest rate, they ought to increase the money supply by purchasing bonds.

2. true, If the public believes the commitment to a nominal anchor to be credible, the effect of a negative aggregate demand shock is for short-run aggregate supply to be unaffected. with a credible nominal anchor, expected inflation does not increase, as a result no upward shift of short run supply curve occur, and the increase in inflation and decrease in output are not as great as they otherwise would be.