Demand Pull Inflation: Suppose that the central bank wants to increase output, but the economy is already at the natural rate.
(a) Show the short and long run effects of a monetary expansion in this situation in the AD/AS model. You can omit the labor market and production function graphs and you should assume sticky prices for the SRAS.
(b) As you can see from above (hint), in the long run output is unchanged but the price level is higher. What happens if the central banks try this strategy over and over again?
(c) Now assume that these repeated increases in the money supply have caused expected inflation to increase. Furthermore, assume the central bank stops its repeated increases of the money supply at the same time (assume M is constant). What is the net effect of the increase in inflation expectations on output, the real interest rate, and the price level in the short run?