Long-run effect of expansionary monetary policy on GDP and price level?

• A. Both GDP and Price Level Rise
• B. Only Price Level Rises
• C. Only GDP Rises
• D. Neither Changes

Answer: (B)

Expansionary monetary policy increases the money supply, which lowers interest rates and boosts spending in the short run. This shifts aggregate demand to the right and can raise real GDP temporarily. But in the long run the economy’s output is determined by real factors like technology and resources, so real GDP returns to potential output. Prices, however, have adjusted upward because there is more money chasing the same amount of goods. As a result, the long-run effect is a higher price level with real GDP returning to its normal level. That’s why the correct result is that only the price level rises in the long run, while GDP does not rise beyond its potential.