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Lucas's monetary theory of the business cycle _____
Lucas's monetary theory of the business cycle _____.
a. helps to explain why output and inflation are negatively correlated
b. assumes that economic agents have perfect information about the economy
c. helps to explain why output and inflation tend to move in the opposite direction over the course of the business cycle
d. relies on the signal extraction problem
e. all of the above
Expert Solution
- Lucas's monetary theory of the business cycle d. relies on the signal extraction problem.
According to Lucas, when there is price movement, a rational economic agent, that is, a supplier, has to estimate whether the observed changes in price implies a fluctuation in the relative demand for his product or a change in general price level resulting from monetary policy. This results in misperceptions that cause the supplier to fail to immediately include the impacts of monetary policy adjustments into his or her expectations resulting in a signal extraction problem occurs. As a result of the misperceptions about the relative prices, changes in real output can occur.
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