Question

Consider two economies, both in recession. In the first economy, all workers have long-term contracts that guarantee high nominal wages for the next five years. In the second economy, all workers have annual contracts that are indexed to changes in the price level. Which economy will return to the natural rate of output first? Explain your response.

Answer 1

In the given scenario, the economy with workers having annual contracts indexed to changes in the price level is likely to return to the natural rate of output first.

Step-by-step explanation:

In the given scenario, the second economy where workers have annual contracts that are indexed to changes in the price level will likely return to the natural rate of output first. This is because the flexible nature of these contracts allows for wage adjustments to align with changes in the price level, which can help stimulate economic activity and restore the economy to its potential GDP more quickly.