In the new classical model, the natural rate hypothesis:
A) argues that the economy may not recover to its natural rate of unemployment without government intervention.
B) indicates that the government will be ineffective in reducing unemployment below its natural rate.
C) suggests that the long-run supply curve is horizontal.
D) predicts that an increase in aggregate demand will permanently lead to a lower natural rate of output.

Question

Quizplus · Accepted Answer

The natural rate hypothesis, a key component of the new classical model, posits that attempts by the government to reduce unemployment below the natural rate (the level of unemployment consistent with equilibrium in the labor market) are ultimately futile, as the economy will adjust back to this natural rate over time. This adjustment mechanism is based on the idea that unemployment can only be reduced in the short term through unexpected inflation, which temporarily lowers real wages. However, once expectations adjust, unemployment returns to its natural rate, rendering government interventions ineffective in the long run.

In the New Classical Model, the Natural Rate Hypothesis