Question

If the public believes the commitment to a nominal anchor to be credible, the effect of

a negative aggregate demand shock is for short-run aggregate supply to be unaffected.

Say whether you think the statement is true,

false, or uncertain; and support your answer in a few lines.

Answer 1

Answer: If the public believes the commitment to a nominal anchor to be credible, the effect of a negative aggregate demand shock on short-run aggregate supply is uncertain to say as a negative demand-side shock can also bring about negative multiplier effects and also a negative accelerator effect on the level of investment spending. Supply-side shocks affect short run aggregate supply and can also affect a country's long-run productive potential.

Negative Demand Shocks like terrorist attacks, natural disasters or stock market crashes create fear. In this mindset, people are more inclined to save rather than consume. Further, they are less inclined to take risks to start a business or pursue an education, which are activities integral to economic growth. Although these decisions may be rational on an individual basis, on an aggregate basis, it can lead to crippling economic losses. To balance such a negative demand shock, governments may be inclined to lower interest rates, cut taxes or increase spending to reverse a self-reinforcing negative spiral. This is essentially introducing a positive demand shock to counter act a negative shock. They can lead to surging or falling prices as supply tends to be inelastic in the short-term. Over time, the shock fades and supply responds to find a new, sustainable equilibrium.