Draw two SP curves intersecting LP;call the upper intersection point A and the lower point B.The Fed promises to reduce inflation while maintaining natural unemployment.If the public believes the Fed,the economy moves from ________.Then if the Fed turns out to be time-inconsistent,breaking its promise and trading off ________ inflation for lower unemployment,the public revises the way it forms inflation expectations so that in the long run the economy stays at ________.
A)A to B,lower,B which is superior to A
B)A to B,higher,A which is inferior to B
C)A to B,lower,A which is superior to B
D)B to A,higher,B which is superior to A
E)B to A,lower,B which is inferior to A

Question

Quizplus · Accepted Answer

DIf the public believes the Fed's promise to reduce inflation while maintaining natural unemployment, the economy initially moves from A to B, reflecting the public's adjusted expectations for lower inflation. However, if the Fed is time-inconsistent and opts for lower unemployment at the cost of higher inflation, the public will revise its inflation expectations. In the long run, this leads to a situation where the economy stays at B (D), which is considered superior to A because it reflects a point of higher output or employment, despite the Fed's initial promise aiming for lower inflation (B).

Draw Two SP Curves Intersecting LP;call the Upper Intersection Point