If people have rational expectations a monetary policy contraction that is announced and is credible could ?

Correct answer: A. reduce inflation with little or no increase in unemployment

  • A. reduce inflation with little or no increase in unemployment
  • B. Increase inflation but would decrease unemployment by an unusually large amount
  • C. increase inflation with little or no decrease in unemployment
  • D. reduce inflation but it would increase unemployment by an unusually large amount

Explanation

With rational expectations, a credible contraction is incorporated into wage and price decisions quickly, lowering expected and actual inflation without requiring a large rise in unemployment. This is why the sacrifice ratio can be small.

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