Suppose the economy exhibits a large, unexpected increase in productivity growth that lasts for a decade. Policymakers are (quite reasonably) slow to learn what has happened to potential output and incorrectly interpret the increase in output as a boom that leads actual output to exceed potential. Suppose they adjust macroeconomic policy so that the mismeasured level of short-run output is zero.
(a) What happens to the true amount of short-run output Y?
(b) What happens to inflation over time?
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