If, in a surprise victory, a new administration that the public believes will pursue inflationary policy is elected to office, predict what might happen to the level of output and inflation even before the new administration comes into power.

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The Economics of Money, Banking, and Financial Markets

Chapter 25

The Role of Expectations in Monetary Policy

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supposing that there was a surprise victory of an of an administration who the public believed was going to pursue inflationary policy. What could we expect to happen to the level of output and inflation even before this administration comes into power? Well, assuming that the public believes that this administration is going to pursue inflationary policy. What we're seeing here is this increase in inflation expectations. Therefore the public has this expectation that inflation is going to rise once this administration comes into power. Well, an increase in inflation expectations, we know, shifts the short run aggregate supply curve. So we're seeing are short run aggregate supply curve shift to the left to SRS too, Which gives us this new equilibrium level of output and price level. So we're seeing here that are output has now decreased from Y1 to Y two and that the price level has increased in keeping in mind this is occurring even before this inflation comes and even before this administration comes into power and actually pursues any inflationary policy. It simply, as a result of this, of these inflation expectations and these inflation expectations are leading to this increase in the price level or an increase in inflation and a decrease in output.

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