Question

Revisit the equation from last week: π t −π te =−α(u t −u n ) Where: π t is inflation in the current time period π te is expected inflation −α represents the strength of the effect of unemployment on wage u t is unemployment in the current time period u n is natural rate of unemployment Using the equation above, answer the following questions: 1) If unemployment is below the natural rate, inflation will be (HIGHER/LOWER) than expected. (Circle one). Explain briefly using the equation.

Answer 1

If unemployment is below the natural rate, inflation will be higher than expected.

Step-by-step explanation:

If unemployment is below the natural rate, inflation will be HIGHER than expected. This can be explained by the equation πt - πte = -α(ut - un). The equation suggests that when unemployment is below the natural rate (ut < un), the difference ut - un will be negative. Since the right side of the equation is negative, it implies that the left side (inflation) will be positive, indicating that inflation will be higher than expected.