Macroeconomics 6th Edition by Robert Hall,Marc Lieberman

Exercise 8

This chapter mentioned what would happen if the Fed over- or underestimated the natural rate of unemployment. Using the AD-AS model, suppose the economy is at the true natural rate of unemployment, so that GDP is at its potential level. Suppose, too, that the Fed wrongly believes that the natural rate of unemployment is higher (potential GDP is lower) and acts to bring the economy back to its supposed potential. What will the Fed do? What will happen in the short run? If the Fed continues to maintain output below potential, what will happen over the long run?