Refer to Exhibit 4. If the economy is currently in a recession, represented by point B in Exhibit 4, and policymakers decide to let the economy self-correct to its long-run natural rate, what will happen?

Show Answers

Individuals will lower their inflation expectations, causing the short-run aggregate supply curve to shift rightward.Individuals will increase their inflation expectations, leading to a leftward shift in aggregate demand.Individuals will raise their inflation expectations, resulting in a leftward movement of the short-run aggregate supply.Individuals will lower their inflation expectations, which will shift aggregate demand to the right.

Explanation

When the economy is in a recession and allowed to adjust naturally, people tend to decrease their expected price levels. This reduction in price expectations causes the short-run aggregate supply to shift to the right, moving the economy back toward its natural output level.