Reference no: EM131205309

Suppose that consumer confidence unexpectedly rises six months before the central bank detects the change or its magnitude. What happens to inflation and output in that six-month interval? How does monetary policy return the economy to long-run equilibrium at the initial inflation target?

The rise in consumer confidence implies (rightward, leftward) a shift in the (long-run aggregate supply curve, short-run aggregate supply curve, dynamic aggregate demand curve). This shift leads to a (fall, rise) in the inflation rate, along with (a decrease, an increase) in output. Since the central bank took six months to recognize the change, the central bank's response is delayed. Once it recognizes the change, the central bank will act to shift the MPRC curve (to the left, to the right), moving the (long-run aggregate supply curve, short-run aggregate supply curve, dynamic aggregate demand curve) back to its original position. The inflation rate and output return to their initial levels. In the meantime, however, there is a business cycle (recession, expansion) accompanied by a (rise, fall) in inflation.