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Exam 35: The Short-Run Trade-Off Between Inflation and Unemployment

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Question 21

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Rational expectations refers to _____.

A) the theory according to which people optimally use all the information they have, including information about government policies, when forecasting the future.
B) theory explaining the returns in risky assets
C) the theory explaining how the government responds to exogenous shocks to the economy.
D) the theory according to which the central bank establishes the inflation target.

E) None of the above
F) B) and C)

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Question 22

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The natural rate hypothesis states that if policymakers choose higher inflation in order to reduce unemployment below the natural rate, they will succeed at reducing unemployment permanently.

A) True
B) False

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Question 23

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According to the theory of rational expectations, an announced policy of reducing the rate of growth of the money supply will result in people:

Rational expectations theory is based on the assumption that people optimally allocate their incomes - that is, they decide how much they consume and how much they save.

What is the lesser of two evils - high unemployment or high inflation? Do policy makers have to make this choice all the time? If so, what is the correct choice, according to this chapter?

Using the theory of rational expectations of inflation, identify how statements made by the government and RBA, could affect the rate of inflation.

If the RBA raises its inflation target, how would such change in monetary policy affect the short-run Phillips curve? How about its long-run counterpart?

If the long-run Phillips curve shifts to the right, the economy will have _____ for any given rate of money growth and inflation.

The equation by Friedman and Phelps of a relationship between the unemployment rate and its natural rate can be summarised as:

If the sacrifice ratio is five, it means that for each percentage point that inflation is reduce, one per cent of annual output must be sacrificed in the transition.

According to Friedman and Phelps, policymakers _____.

Phillips's discovery in the UK was supported by a similar negative correlation between inflation and unemployment in data for the United States.

The Phillips curve is:

Explain how a demand shock can affect the unemployment rate in the short run.

Economists have various theories of how expectations may be formed.The textbook discusses the theory of rational expectations.Another possibility is that people have adaptive expectations, which means they form their expectations based on recent history.(For example, people might guess that the inflation rate next year will be the same as it was this year.) Would it be easier to eliminate inflation when people have rational expectations or when they have adaptive expectations?

The long-run Phillips curve is_____ at the _____.

Samuelson and Solow reasoned that the trade-off between inflation and unemployment arose because low unemployment was associated with high aggregate demand, and because high demand puts upward pressure on wages and prices throughout the economy.

An increase in expected inflation:

According to the textbook, the sacrifice ratio should be ignored when attempting to reduce inflation beyond acceptable targets as continued inflation has dire consequences.

According to Friedman and Phelps, which of the following does not influence the economy's unemployment rate in the long run?