Question

If the original level of aggregate demand is AD0, then an expansionary monetary policy that shifts aggregate demand to AD1 only creates an inflationary increase in the price level, but it does not alter GDP or unemployment. From this perspective, all that monetary policy can do is to lead to low inflation or high inflation—and low inflation provides a better climate for a healthy and growing economy. After all, low inflation means that businesses making investments can focus on real economic issues, not on figuring out ways to protect themselves from the costs and risks of inflation. In this way, a consistent pattern of low inflation can contribute to long-term growth.

(True/False)

Answer 1

The statement given is false; an expansionary monetary policy does initially affect GDP and unemployment and only leads to inflation if sustained beyond the economy's potential output.

Step-by-step explanation:

The statement is indeed false. In the neoclassical economic model, monetary policy can impact long-term inflation rates. Central bankers often prioritize controlling inflation, recognizing the role of monetary policy in influencing the overall price level. However, the effects of an expansionary monetary policy extend beyond changes in inflation. In the short run, such a policy can shift the aggregate demand (AD) curve, leading to an increase in GDP and a decrease in unemployment until the economy approaches its potential output.

Only when the economy operates beyond its potential output—where the aggregate supply curve becomes vertical—would further expansionary policies primarily result in inflation without substantially affecting GDP or unemployment rates. Therefore, the influence of monetary policy on the economy encompasses both short-term output and employment dynamics as well as long-term inflation considerations.