Monetary Policy in Highland
Highland has had inflation of 15% for many years. Highland establishes a new central bank, the Bank of Highland, with the hopes of reducing the inflation rate.
-Refer to Monetary Policy in Highland. The Bank of Highland reduced inflation to its announced goal of 5%. However its efforts made the unemployment rate rise by 10 percentage points for a year while output fell by 30 percent for a year. Which of the following is correct?
A)Initially people's inflation expectations had been higher than 5%. The sacrifice ratio was 3.
B)Initially people's inflation expectations had been higher than 5%. The sacrifice ratio was 1.
C)Initially people's inflation expectations had been lower than 5%. The sacrifice ratio was 3.
D)Initially people's inflation expectations had been lower than 5%. The sacrifice ratio was 1.

Question

Quizplus · Accepted Answer

The initial inflation expectations were higher than 5% because the central bank's actions led to a significant increase in unemployment and a decrease in output, indicating a strong adjustment to lower inflation expectations. The sacrifice ratio, calculated as the percentage loss in output divided by the reduction in inflation, is 3 (30% output loss / 10% inflation reduction).