Suppose two groups of workers are bargaining for two-year contracts, one on even years and one on odd years. Both set wages equal to a constant times a price level in the negotiating year and increase it by last year's inflation in the second year of the contract. The Fed initiates four years of disinflationary monetary policy. You should expect to see
A) no recession.
B) some reduction in actual GDP relative to its potential.
C) some increase in unemployment above the natural rate.
D) some pressure to adjust the inflation index of the contract in exchange for increased job security.
E) b, c, and d.

Question

Quizplus · Accepted Answer

The Fed's disinflationary policy would likely lead to a reduction in actual GDP relative to its potential due to lower spending and investment, an increase in unemployment above the natural rate as firms adjust to lower prices and demand, and pressure to adjust the inflation index in contracts for increased job security as workers and employers negotiate terms in a changing economic environment.

Suppose Two Groups of Workers Are Bargaining for Two-Year Contracts