Consequences of a Positive Demand Shock without an Inflation Target

Consider two economies, A and B, that are identical except for their monetary policy frameworks. Both experience a sudden, significant increase in consumer spending. In Economy A, the central bank has a well-known and credible long-term goal for maintaining low and stable price increases. In Economy B, the central bank has no explicit long-term goal for price stability, and its policy actions are less predictable. What is the most likely difference in the inflationary outcome between the two economies in the medium term, after the initial effects of the spending increase?

Monetary Policy Framework and Economic Shocks

An economy operates without a publicly announced, credible long-term goal for price stability. It experiences a sudden and large positive shock to aggregate demand (e.g., a government spending boom). Arrange the following economic events in the most likely causal sequence that would follow this shock.

Monetary Policy Frameworks and Demand Shocks

An economy experiences a sudden, positive aggregate demand shock (e.g., a surge in consumer confidence). Match each monetary policy framework below with its most likely medium-term outcome following this shock.

Inflationary Dynamics after a Demand Shock

In an economy that operates without a credible, publicly-known long-term goal for price stability, a sudden, positive shock to aggregate demand will cause a temporary increase in inflation that naturally returns to its pre-shock level once the initial demand pressure subsides.

In an economy lacking a credible, long-term goal for price stability, a positive aggregate demand shock can cause inflation expectations to become __________, leading to a persistent upward drift in the inflation rate even after the initial shock has dissipated.

Monetary Policy Framework and Economic Shocks

Evaluating Monetary Policy in the Absence of an Inflation Target