Suppose the natural rate of unemployment is 4 percent.Then suppose that Parliament passes laws that make the labour market less flexible,so the natural rate of unemployment rises to 5 percent.If the sacrifice ratio is 3,how much is the inflation rate that is consistent with the increased natural level of unemployment,such that there is no loss in output growth?

Question

Quizplus · Accepted Answer

The sacrifice ratio indicates the percentage loss in output for a 1% reduction in inflation. With a 1% increase in the natural rate of unemployment, the inflation rate must decrease by 3% (sacrifice ratio of 3) to maintain output growth. Thus, the inflation rate consistent with the new natural unemployment rate is 6%.

Suppose the Natural Rate of Unemployment Is 4 Percent