The Continuous Nature of Inflation Targeting

Evaluating a Monetary Policy Response

An economy is experiencing a sudden, sharp increase in inflation. In response, its central bank raises its policy interest rate by a small amount, stating that it believes the inflation shock is temporary. Over the next year, inflation continues to rise, and businesses and consumers begin to expect high inflation to persist. Which of the following statements best analyzes the central bank's initial policy action and its consequences?

Consequences of a Monetary Policy Overreaction

Match each central bank monetary policy response to a sudden inflation shock with its most likely economic outcome.

Comparing Central Bank Policy Errors