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Assume agents in the economy have adaptive expectations and the inflation rate is 2 percentage points above the target rate of inflation due to a positive aggregate demand shock.

If the monetary authority raises nominal rates by 1 percentage point,

A

inflation and output will fall.

B

inflation and output will continue to rise.

C

inflation will fall, but output will rise.

D

inflation will rise, but output will return to its natural rate.

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