If workers and firms ignore inflation or form their inflation expectations adaptively,expansionary monetary policy will lower unemployment permanently.

Question

Quizplus · Accepted Answer

If workers and firms ignore inflation or have adaptive inflation expectations, expansionary monetary policy will only temporarily lower unemployment. As inflation expectations rise, workers and firms will adjust their behavior, resulting in an increase in the natural rate of unemployment. This is known as the Phillips curve trade-off, where there is a short-run inverse relationship between inflation and unemployment, but in the long run, the trade-off disappears and the economy returns to its natural rate of unemployment regardless of the level of inflation.

If Workers and Firms Ignore Inflation or Form Their Inflation