Answer to Question #175394 in Macroeconomics for Lily

Question

True or False?

 Suppose price index that is used to guide central bank policy increases from 120 to 126. If the central bank has an inflation target of 2%, it should pursue an expansionary monetary policy. [Hint: Use an AD-AS diagram in your answer.] 

Answer 1

. FALSE.

It should use a contractionary monetary policy. Pursue of an expansionary monetary policy would lead to hyper inflation. 

-Hence to control inflation , we must use a contractionary monetary policy. This would shift AD curve to the left. This reduces the price level to within the central bank inflation target of 2% and as an effect of the policy, national income too .