If policymakers do nothing in response to an inflationary gap, what will happen?

Question

Quizplus · Accepted Answer

An inflationary gap occurs when aggregate demand exceeds aggregate supply at the full employment level, leading to higher prices (inflation) and lower unemployment. If policymakers do not intervene, the economy may adjust on its own over time through mechanisms like increased wage demands, which can lead to higher production costs and eventually reduce demand, slowing the economy and increasing unemployment. This process, however, can lead to a period of stagflation, characterized by higher unemployment and continued inflation, hence a slow movement toward higher unemployment and higher inflation.

If Policymakers Do Nothing in Response to an Inflationary Gap