If a central bank were required to target inflation at zero,then when there was a positive aggregate supply shock the central bank
A)would have to increase the interest rate.This would move unemployment closer to the natural rate.
B)would have to increase the interest rate.This would move unemployment further from the natural rate.
C)would have to decrease the interest rate.This would move unemployment closer to the natural rate.
D)would have to decrease the interest rate.This would move unemployment further from the natural rate.

Question

Quizplus · Accepted Answer

If a positive aggregate supply shock occurs, then the general price level would decrease. In order to maintain the target inflation rate of zero, the central bank would need to decrease the interest rate to encourage borrowing and spending, and hence increase aggregate demand. This increase in aggregate demand would mean that unemployment would move further from the natural rate. Therefore, the correct choice is D.

If a Central Bank Were Required to Target Inflation at Zero,then