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Test prep answers - Advocates of the rational expectations...

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Advocates of the rational expectations approach predict that an expectation of higher energy prices will raise the sacrifice ratio making the Fed’s job more difficult. Stabilization policy aims at keeping output and employment at their natural rates. Equilibrium levels of income and interest rates are negatively related in the goods and services market and equilibrium levels of income and interest rates are positively related in the market for real money balances. The model of short run aggregate supply discussed in Chapter 13 implies that if the price level is higher than expected, then output exceeds the natural rate of output. (More is supplied than demanded) Stagflation occurs when prices rise and output falls. The monetary transmission mechanism in the IS-LM model is a process whereby an increase in the money supply increases the demand for goods and services by lowering the interest rate so that interest rate so that investment spending increases.
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Test prep answers - Advocates of the rational expectations...

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