Monetary Policy in Southland
In Southland the Department of Finance is responsible for monetary policy. Southland has had an inflation rate of 25% for many years.
-Refer to Monetary Policy in Southland. Suppose the Southland Department of Finance has run a public relations campaign claiming it will reduce inflation to 12.5% and actually reduces inflation to that level. Suppose at first that the public thought inflation would only drop to 18%, but eventually become convinced that the inflation rate will stay at 12.5%.

Question

Quizplus · Accepted Answer

In the short run, unemployment rises due to the unexpected reduction in inflation. In the long run, as expectations adjust to the new inflation rate, unemployment returns to its natural rate.