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 the unemployment rate was on average higher for many years after. A newspaper editorial argues that the unemployment rate had moved to this higher natural rate because (1) by itself the decrease in inflation had permanently increased unemployment and (2) that at the same time the central bank was fighting inflation the government of Highland had made a large increase in the minimum wage. Which of these arguments is consistent with the Phillip's curve model?
A)both explanations 1 and 2
B)neither explanation 1 nor 2
C)explanation 1 but not explanation 2
D)explanation 2 but not explanation 1

Question

Quizplus · Accepted Answer

Explanation 2 is consistent with the Phillips curve model, which suggests that higher minimum wages can lead to higher unemployment. Explanation 1 is not consistent because the Phillips curve does not imply that a decrease in inflation permanently increases unemployment.