Question

If policymakers attempt to offset a favorable inflation shock with monetary _____, the resulting long-run equilibrium will be at _____ inflation rate compared to allowing the self-correcting mechanism return the economy to potential output.

Answer 1

1. Easing

2. A higher

Step-by-step explanation:

An adverse inflation shock when modeled is the upward shift of the Short run aggregate supply curve, this brings about higher inflation and causes a lowering of output.

The self-correcting mechanism of the economy will cause inflation to decrease gradually until the economy is back in long-run equilibrium at the original level of inflation.

If there is an intervention with monetary easing, aggregate demand will shift forward and a long-run equilibrium will be established where inflation remains at the higher level.