Under adaptive expectations, the short-term effect of an unanticipated shift to a more expansionary macroeconomic policy will be a
A) temporary reduction in the unemployment rate.
B) permanent reduction in the unemployment rate.
C) temporary reduction in the inflation rate.
D) permanent reduction in the inflation rate.

Question

Quizplus · Accepted Answer

Under adaptive expectations, individuals base their expectations of future inflation and employment on past experiences. Therefore, an unanticipated shift to a more expansionary macroeconomic policy will temporarily reduce the unemployment rate because individuals have not yet adjusted their expectations and are likely to increase their consumption and investment in response to the policy change. However, over time, as individuals adjust their expectations and anticipate higher inflation, the short-term reduction in unemployment will be reversed, and the economy will return to its previous equilibrium level of unemployment.

Under Adaptive Expectations, the Short-Term Effect of an Unanticipated Shift