If inflation expectations are rationally formed,
A) the Phillips curve is essentially horizontal.
B) the monetary policy reaction function is essentially horizontal.
C) the Phillips curve is essentially vertical.
D) the monetary policy reaction function is essential vertical.

Question

Quizplus · Accepted Answer

When inflation expectations are rationally formed, individuals anticipate future inflation accurately, leading to adjustments in wage and price setting that render the Phillips curve vertical in the long run. This means that there is no trade-off between inflation and unemployment in the long run, as any attempt to reduce unemployment below its natural rate through monetary expansion will only lead to higher inflation without affecting unemployment.

If Inflation Expectations Are Rationally Formed