In the short run, if consumers lose confidence in the state of the economy, both the equilibrium real GDP growth rate and the inflation rate are likely to fall. This is because decreased consumer confidence leads to a decrease in spending, which in turn reduces aggregate demand and slows down economic growth. Additionally, businesses may cut back on production, leading to a decrease in output. With lower demand and output, inflationary pressures are also reduced.
In the long run, the inflation rate is expected to fall even further as the economy adjusts to the lower levels of demand and output. However, the equilibrium real GDP growth rate is likely to return to its initial rate pre-shock. This is because, in the long run, the economy has time to adjust to changes in consumer confidence and find a new equilibrium. As businesses and consumers adapt to the new conditions, the economy can stabilize and return to its long-term growth trend.
To summarize:
- Short run: Inflation and GDP growth fall
- Long run: Inflation falls further and GDP growth returns to its initial rate pre-shock. (120 words)