Monetary Policy in Flosserland

In Flosserland, the Department of Finance is responsible for monetary policy. Flosserland has had an inflation rate of 25% for many years.

-Refer to Monetary Policy in Flosserland.Suppose that the Flosserland Department of Finance has run a public relations campaign claiming it will reduce inflation to 12.5% but it actually raises inflation to 30%.Suppose that the public had expected that the Department of Finance would reduce inflation but only to 22%.Then
A)unemployment falls,but it would have fallen less if people had been expecting 12.5% inflation.
B)unemployment falls,but it would have fallen less if people had been expecting 25% inflation.
C)unemployment rises,but it would have risen less if people had been expecting 12.5% inflation.
D)unemployment rises,but it would have risen less if people had been expecting 25% inflation.

Question

Monetary Policy in Flosserland

In Flosserland, the Department of Finance is responsible for monetary policy. Flosserland has had an inflation rate of 25% for many years.

-Refer to Monetary Policy in Flosserland.Suppose that the Flosserland Department of Finance has run a public relations campaign claiming it will reduce inflation to 12.5% but it actually raises inflation to 30%.Suppose that the public had expected that the Department of Finance would reduce inflation but only to 22%.Then
A)unemployment falls,but it would have fallen less if people had been expecting 12.5% inflation.
B)unemployment falls,but it would have fallen less if people had been expecting 25% inflation.
C)unemployment rises,but it would have risen less if people had been expecting 12.5% inflation.
D)unemployment rises,but it would have risen less if people had been expecting 25% inflation.

Quizplus · Accepted Answer

Unemployment falls because the actual inflation (30%) is higher than the expected inflation (22%), leading to a short-term boost in economic activity. If people had expected 25% inflation, the surprise would have been smaller, and unemployment would have fallen less.