Question

Under the natural rate hypothesis, expansionary monetary and fiscal policies can at best produce a (an): a. short-run change in the long-run Phillips curve. b. short-run change in the unemployment rate. c. permanent change in the inflation rate. d. permanent change in the unemployment rate. 6. Under adaptive expectations theory, people expect the rate of inflation this year to be: a. the rate based on predictable and fiscal policies. b. the same as last year. c. zero, regardless of the rate last year. d. All of the above. e. None of the above. 7. "Preannounced, stable policies to achieve a low and constant money supply growth and a balanced federal budget are therefore the best way to lower the inflation rate." This statement best illustrates the: a. Keynesian theory. b. rational expectations theory. c. adaptive expectations theory. d. supply-side theory. e. incomes policy.

Answer 1

Under adaptive expectations theory, people expect the rate of inflation this year to be: b. the same as last year. According to

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, adaptive expectations is a hypothesized process by which people form their expectations about what will happen in the future based on what has happened in the past. People refer to past inflation rates to infer some consistencies and could derive a more accurate expectation the more years they consider. One simple version of adaptive expectations is stated in the following equation, where E(t+1) is the next year's rate of inflation that is currently expected; E(t) is this year's rate of inflation that was expected last year; and π(t) is this year's actual rate of inflation: E(t+1) = E(t) + α[π(t) - E(t)], where α is a constant between 0 and 1. This equation shows that people update their expectations of inflation based on the difference between the actual inflation rate and their previous expectation. If the actual inflation rate is the same as their previous expectation, then their expectation for the next year's inflation rate will also be the same as last year. Therefore, the answer is b. the same as last year.

"Preannounced, stable policies to achieve a low and constant money supply growth and a balanced federal budget are therefore the best way to lower the inflation rate." This statement best illustrates the: b. rational expectations theory. According to6, the rational expectations theory assumes that economic agents make their predictions based on all available information, including information about government policies. If the government announces a policy to achieve a low and constant money supply growth and a balanced federal budget, economic agents will factor that into their expectations of future inflation. Therefore, the statement best illustrates the rational expectations theory.