Suppose policymakers think the natural rate of unemployment is higher than it really is, so policies such as decreasing aggregate demand are designed to move the economy to the estimated natural rate.If the policies are continued over the long run, what will be the result?

Question

Quizplus · Accepted Answer

If policymakers overestimate the natural rate of unemployment and implement contractionary policies to decrease aggregate demand, the economy will operate below its potential GDP. This is because the policies will reduce economic activity more than necessary, leading to lower employment and output than the economy is capable of sustaining at its actual natural rate of unemployment.

Suppose Policymakers Think the Natural Rate of Unemployment Is Higher