-Refer to the above figure. Suppose the natural rate of unemployment is 5 percent. If the government tried to reduce unemployment to 4 percent and keep it there, it must
A) raise unemployment benefits.
B) accept a permanent inflation rate of 1 percent.
C) generate higher and higher inflation rates or else people will adjust their behavior and the unemployment rate will return to 5 percent.
D) use contractionary fiscal and expansionary monetary policy.

Question

-Refer to the above figure. Suppose the natural rate of unemployment is 5 percent. If the government tried to reduce unemployment to 4 percent and keep it there, it must
A) raise unemployment benefits. 
B) accept a permanent inflation rate of 1 percent. 
C) generate higher and higher inflation rates or else people will adjust their behavior and the unemployment rate will return to 5 percent. 
D) use contractionary fiscal and expansionary monetary policy.

Quizplus · Accepted Answer

To maintain unemployment below the natural rate, the government would need to generate higher and higher inflation rates. This is because people will eventually adjust their expectations about inflation, which will negate the initial effect of the policy on unemployment, leading it to return to its natural rate unless inflation is continuously accelerated.

-Refer to the Above Figure