Question

The policy relevance of new Keynesian inflation dynamics based on the theory of small menu costs and sticky prices depends on the exploitability of the implied relationship between inflation and real GDP. Explain in your own words why the average time between price adjustments by firms is a crucial determinant of whether policymakers can actively exploit this relationship to try to stabilize real GDP.

Short answer

There would be a brief run trade-off between real GDP and inflation

Step-by-step solution

Given Information 

Its exploitability of inferred link among price and economic GDP is crucial to a notion of little menu costs and sticking price.

Explanation

• Considering the policy relevance of recent Keynesian inflation dynamics, initially there's slow adjustment of the worth level in response to the increased aggregate demand followed by later higher inflation.
• If the everyday time between price adjustments by firms is critical, then within the short run aggregate supply curve would be considered as horizontal, as hypothesized by the new Keynesian theorists.
• As a result, there would bea brief run trade-off between real GDP and inflation.