Suppose we observe several years of falling inflation rates for an economy. Which of the following would best explain this phenomenon?
A) Unemployment is at the natural rate.
B) The unemployment rate is constant at the natural rate.
C) The unemployment rate is below the natural rate.
D) The unemployment rate is above the natural rate.
E) Aggregate output is increasing.

Question

Quizplus · Accepted Answer

According to the Phillips curve, there is an inverse relationship between inflation and unemployment. When the unemployment rate is above the natural rate, there is downward pressure on wages which leads to lower prices and lower inflation. Therefore, a falling inflation rate coupled with several years of observation would suggest that the unemployment rate is above the natural rate.

Suppose We Observe Several Years of Falling Inflation Rates for an Economy