Assume that people have rational expectations and that the economy is described by the sticky- price model. Explain why each of the following propositions is true. 1. Only unanticipated changes in the money supply affect real GDP. Changes in the money supply that were anticipated when prices were set do not have any real effects.
2. If the Fed sets the money supply at the same time as people are setting prices, so that everyone has the same information about the state of the economy, then monetary policy cannot be used systematically to stabilize output. Hence, a policy of keeping the money supply constant will have the same real effects as a policy of adjusting the money supply in response to the state of the economy. (This is called the policy irrelevance proposition.)
3. If the Fed sets the money supply well after people have set prices, so that the Fed has collected more information about the state of the economy, thenmonetary policy can be used systematically to stabilize output.