The natural rate hypothesis states that when the inflation rate _______, in the short run the unemployment rate ________ and in the long run the unemployment rate ________.
A) rises, decreases; returns to the natural unemployment rate
B) rises, decreases; decreases
C) falls, decreases; decreases
D) falls, decreases; returns to the natural unemployment rate
E) falls, increases; decreases

Question

Quizplus · Accepted Answer

According to the natural rate hypothesis, when the inflation rate rises, in the short run the unemployment rate decreases (due to firms hiring more workers to meet increased demand), but in the long run, the unemployment rate returns to the natural unemployment rate, as inflation expectations adjust and wages and prices adjust accordingly. Similarly, when the inflation rate falls, in the short run the unemployment rate increases (due to firms reducing production and laying off workers), but in the long run, the unemployment rate returns to the natural unemployment rate. Therefore, choice A is the best answer.

The Natural Rate Hypothesis States That When the Inflation Rate