Suppose that,starting at point A in the diagram below,the central bank wants to lower the inflation rate from = 6% per year to = 3% per year.To achieve this goal,the Bank dramatically increases the real interest rate,shifting the aggregate demand line to ADI₁.In the short run,this policy will cause a recession (point B),but in the long run,the economy may be expected to return to its potential (point C).How long the transition from B to C will take,and therefore,how much output must be sacrificed to achieve the reduction in inflation will depend A) only on how quickly growth in wages and production costs adjust downward. B) only on how quickly inflation declines. C) only on how quickly the public's expectations of inflation are revised downward. D) only on how quickly aggregate demand and output respond to interest rate cuts by the Bank of Canada. E) on how quickly growth in wages and production costs,inflation,the public's expectations of inflation,and aggregate demand and output adjust.

Question

Quizplus · Accepted Answer

The transition from point B to point C and the amount of output that must be sacrificed to achieve the reduction in inflation depend on the speed of adjustment of various factors, such as growth in wages and production costs, inflation, the public's expectations of inflation, and aggregate demand and output. Therefore, all of these factors must be considered, making choice E the best answer.

Suppose That,starting at Point a in the Diagram Below,the Central