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 that it actually leaves inflation at 25%.Suppose that the public had expected that the Department of Finance would reduce inflation,but only to 20%.Then
A)unemployment falls,but it would have fallen more if people had been expecting 12.5% inflation.
B)unemployment falls,but it would have fallen more if people had been expecting 22% inflation.
C)unemployment rises,but it would have risen more if people had been expecting 12.5% inflation.
D)unemployment rises,but it would have risen more if people had been expecting 22% 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 that it actually leaves inflation at 25%.Suppose that the public had expected that the Department of Finance would reduce inflation,but only to 20%.Then
A)unemployment falls,but it would have fallen more if people had been expecting 12.5% inflation.
B)unemployment falls,but it would have fallen more if people had been expecting 22% inflation.
C)unemployment rises,but it would have risen more if people had been expecting 12.5% inflation.
D)unemployment rises,but it would have risen more if people had been expecting 22% inflation.

Quizplus · Accepted Answer

If the public had expected inflation to be reduced to only 20%, then the campaign promising a reduction to 12.5% would have raised expectations beyond what was feasible. As a result, when inflation was only reduced to 25% instead of the promised 12.5%, it would have had a smaller impact on unemployment because the public's expectations were already elevated. Therefore, unemployment falls, but it would have fallen more if people had been expecting 12.5% inflation.