From 1994 to 1999, inflation in the United States was relatively constant at approximately 2.5 percent. When inflation is constant for an extended period, which of the following is most likely?
A) People will correctly anticipate the actual inflation rate, and the actual rate of unemployment will approach the natural rate of unemployment.
B) People will correctly anticipate the actual inflation rate, and the actual rate of unemployment will exceed the natural rate of unemployment.
C) The actual inflation rate will be greater than the anticipated rate, leading to an actual rate of unemployment that exceeds the natural rate of unemployment.
D) Actual inflation will be less than the anticipated rate, leading to an actual rate of unemployment that exceeds the natural rate of unemployment.

Question

Quizplus · Accepted Answer

When inflation is constant for an extended period, people will be able to correctly anticipate the actual inflation rate. This will lead to a situation where the actual rate of unemployment will approach the natural rate of unemployment. The reason behind this is that when people accurately predict the rate of inflation, they will demand higher wages, which will eventually lead to an increase in the cost of goods and services. As a result, businesses may need to increase their prices to maintain their profit margins, leading to an increase in the overall price level. This increase in price will continue until the real wage rate (the nominal wage rate adjusted for inflation) returns to its equilibrium level. This equilibrium level corresponds to the natural rate of unemployment, that is, the rate of unemployment that exists when the economy is in a steady-state, and the labor market is in equilibrium.

From 1994 to 1999, Inflation in the United States Was