Question

You are studying abroad in Australia for a semester. Unemployment has been creeping up and currently stands at 6%. This rate is getting a little too high for comfort, so the central bank of Australia decides to do something about it. When you arrived in the country, inflation was hovering around 3% and had been at that level for a few years. The central bank’s action leads inflation to increase to 5%. A. What happens to unemployment in the short run if inflation is expected to be 0%? B. What happens to unemployment in the short run if citizens of Australia have adaptive expectations? C. What happens to unemployment in the short run if citizens of Australia have rational expectations?

Answer 1

Answer:

A. What happens to unemployment in the short run if inflation is expected to be 0%? -  Unemployment will fall because the central bank has injected money into the economy, yet inflation remains low. This scenario leads to a higher employment rate.

B. What happens to unemployment in the short run if citizens of Australia have adaptive expectations? - Australians will expect inflation to go back to hovering around 3%, and will reduce investment, this will make unemployment increase,

C. What happens to unemployment in the short run if citizens of Australia have rational expectations? - Australians will find it profitable to hire in the short-run because their real money balances are high because inflation is very low.