Assume output is at its full-employment level and the Fed restricts money supply.What is the most likely outcome?
A)an immediate decrease in prices, with no impact on output
B)no change in nominal wages in the short run, but a decline in output and prices in the medium run
C)no change in real wages, but a decline in output and prices in the medium run
D)a decrease in nominal wages and prices in proportion to money supply, but no change in output and real interest rates in the long run
E)both B and D

Question

Quizplus · Accepted Answer

When the Fed restricts the money supply, nominal wages may not adjust immediately due to contracts and wage stickiness, leading to a decline in output and prices in the medium run as businesses adjust to the tighter monetary conditions (B). In the long run, nominal wages and prices adjust in proportion to the change in money supply, ensuring that output returns to its full-employment level and real interest rates stabilize, reflecting the classical dichotomy and the neutrality of money (D).

Assume Output Is at Its Full-Employment Level and the Fed