However, the economy will soon run into a capacity constraint, meaning that the higher demand caused by a lax monetary policy will result in businesses marking up their prices and unions raising their wage demands. As this occurs, the growth boost will give way to higher inflation and job losses.
The unexpected monetary policy shock will dent the credibility of the central bank, as economic agents will be forced to reassess the central bank’s reaction function. This, in turn, will result in higher inflation expectations, while the medium-term growth prospects will, at best, be no better than they were before.