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Chapter 17: Q. 1 - Critical Thinking Questions (page 391)

How might low inflation expectations on the part of the public help to hold down actual inflation? Explain.

Short Answer

Expert verified

As a result, the long-run Phillips curve was shifted to the right by 6.5%. This is in response to the belief that lowering inflation below its natural level will raise inflation.

Step by step solution

01

Step: 1 Introduction:

A reduction (back to the left shifting) of the aggregate curve is caused by a drop in inflationary expectations. Interest rates, the federal debt, and the money creation are all important aggregate demand factors. Consumers' inflationary expectations are their expectations for future inflation.

02

Step: 2 Unemployment rate:

According to research, the Federal should allow inflation to grow from its present goal level of 2% in order to lower the unemployment rate. The present unemployment rate criterion of 6.5% was too high, and with the promise of low borrowing rates, a more reasonable level will be 5.5%.

03

Step: 3 Actual inflation:

Also with level of unemployment rising, the long-run Phillips curve was shifted to the right by6.5%. This is in response to the belief that lowering inflation below its natural level will raise inflation.

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Most popular questions from this chapter

Normally, when aggregate demand increases, firms find it more profitable to raise prices than to leave prices unchanged. The idea behind the small-menu-cost explanation for price stickiness is that firms will leave their prices unchanged if their profit gain from adjusting prices is less than the menu costs they would incur if they change prices. If firms anticipate that a rise in demand is likely to last for a long time, does this make them more or less likely to adjust their prices when they face small menu costs? (Hint: Profits are a flow that firms earn from week to week and month to month, but small menu costs are a one-time expense.)

Evaluate the implications of behavioral economics for macro policymaking.

People called "Fed watchers" earn their living by trying to forecast what policies the Federal Reserve will implement within the next few weeks and months. Suppose that Fed watchers discover that the current group of Fed officials is following very systematic and predictable policies intended to reduce the unemployment rate. The Fed watchers then sell this information to firms, unions, and others in the private sector. If pure competition prevails, prices and wages are flexible, and people form rational expectations, are the Fed's policies enacted after the information sale likely to have their intended effects on the unemployment rate?

The natural rate of unemployment depends on factors that affect the behavior of both workers and firms. Make lists of possible factors affecting workers and firms that you believe are likely to influence the natural rate of unemployment.

Suppose that more unemployed people who are classified as part of frictional unemployment decide to stop looking for work and start their own businesses instead. What is likely to happen to each of the following, other things being equal?

a The natural unemployment rate

b The economy's Phillips curve
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