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The Short-Run Trade-off between Inflation and Unemployment 8665
13. Friedman and Phelps believed that the natural rate of unemployment was constant.
a. True
b. False
14. The long-run Phillips curve is consistent with monetary neutrality implied by the classical
dichotomy.
a. True
b. False
15. The classical notion of monetary neutrality is consistent both with a vertical long-run aggregate-
supply curve and with a vertical long-run Phillips curve.
a. True
b. False
8666 The Short-Run Trade-off between Inflation and Unemployment
16. Unexpectedly high inflation reduces unemployment in the short run, but as inflation expectations
adjust the unemployment rate returns to its natural rate.
a. True
b. False
17. Although monetary policy cannot reduce the natural rate of unemployment, other types of
government policies can.
a. True
b. False
18. If monetary policy moves unemployment below its natural rate, both expected and actual inflation
will rise.
a. True
b. False
The Short-Run Trade-off between Inflation and Unemployment 8667
19. Neither monetary policy nor any government policy can change the natural rate of unemployment.
a. True
b. False
20. A policy change that reduces the natural rate of unemployment shifts both the long-run aggregate-
supply curve and the long-run Phillips curve left.
a. True
b. False
21. An increase in the inflation rate permanently reduces the natural rate of unemployment.
a. True
b. False
8668 The Short-Run Trade-off between Inflation and Unemployment
22. An increase in the natural rate of unemployment shifts the long-run Phillips curve to the right.
a. True
b. False
23. In the long run people come to expect whatever inflation rate the Fed chooses to produce, so
unemployment returns to its natural rate.
a. True
b. False
24. Just as the aggregate-supply curve slopes upward only in the short run, the trade-off between
inflation and unemployment holds only in the short run.
a. True
b. False
The Short-Run Trade-off between Inflation and Unemployment 8669
25. Just as the aggregate-demand curve slopes downward only in the short run, the trade-off between
inflation and unemployment holds only in the long run.
a. True
b. False
26. The natural rate of unemployment is the same as the socially optimal rate of unemployment.
a. True
b. False
27. The analysis of Friedman and Phelps argues that an expected change in inflation has no impact on
the unemployment rate.
a. True
b. False
8670 The Short-Run Trade-off between Inflation and Unemployment
28. In the Friedman-Phelps analysis, when inflation is less than expected, the unemployment rate is
less than the natural rate.
a. True
b. False
29. According to the Friedman-Phelps analysis, in the long run actual inflation equals expected
inflation and unemployment is at its natural rate.
a. True
b. False
30. An increase in inflation expectations shifts the short-run Phillips curve right and has no effect on
the long-run Phillips curve.
a. True
b. False
The Short-Run Trade-off between Inflation and Unemployment 8671
31. A rightward shift of the short-run aggregate-supply curve results in a more favorable trade-off
between inflation and unemployment.
a. True
b. False
32. A decrease in government expenditures serves as an example of an adverse supply shock.
a. True
b. False
33. An adverse supply shock shifts the short-run Phillips curve to the left.
a. True
b. False
8672 The Short-Run Trade-off between Inflation and Unemployment
34. Other things the same, if the Fed increases the rate at which it increases the money supply then
the short-run Phillips curve shifts right in the long run.
a. True
b. False
35. If prices and wages adjusted rapidly and producers could quickly distinguish the difference
between a change in the price level and a change in the relative price of their products, then an
increase in the money supply growth rate would have at most a very short-lived affect on
unemployment.
a. True
b. False
36. A central bank announces it will decrease the inflation rate by 10 percentage points. People are
skeptical of the announcement, but do expect the central bank will reduce inflation by 5
percentage points and so expected inflation falls by 5 percentage points. If the central bank
decreases inflation by only 3 percentage points then the unemployment rate will fall.
a. True
b. False
The Short-Run Trade-off between Inflation and Unemployment 8673
37. The proliferation of Internet usage serves as an example of a favorable supply shock.
a. True
b. False
38. An adverse supply shock shifts the short-run Phillips curve right and the short-run aggregate-
supply curve left.
a. True
b. False
39. An adverse supply shock shifts the short-run Phillips curve right. If people raise their inflation
expectations, the short-run Phillips curve shifts farther right.
a. True
b. False
8674 The Short-Run Trade-off between Inflation and Unemployment
40. In most of the 1970s, the Fed's policy created expectations of high inflation.
a. True
b. False
41. A decrease in the growth rate of the money supply eventually causes the short-run Phillips curve
to shift right.
a. True
b. False
42. The sacrifice ratio is the percentage point increase in the unemployment rate created in the
process of reducing inflation by one percentage point.
a. True
b. False
The Short-Run Trade-off between Inflation and Unemployment 8675
43. A low sacrifice ratio would make a central bank less willing to reduce the inflation rate.
a. True
b. False
44. Proponents of rational expectations argue that failing to account for peoples' revised inflation
expectations led to estimates of the sacrifice ratio that were too high.
a. True
b. False
45. The sacrifice ratio of the Volcker disinflation was larger than previous estimates had predicted.
a. True
b. False
8676 The Short-Run Trade-off between Inflation and Unemployment
46. U.S. monetary policy in the early 1980s reduced the inflation rate by more than half.
a. True
b. False
47. A central bank can reduce inflation by reducing money supply growth, but it necessarily does so
at the cost of permanently raising the unemployment rate.
a. True
b. False
48. In the long run what primarily determines the natural rate of unemployment? In the long run what
primarily determines the inflation rate? How does this relate to the classical dichotomy?
The Short-Run Trade-off between Inflation and Unemployment 8677
49. Are the effects of an increase in aggregate demand in the aggregate demand and aggregate
supply model consistent with the Phillips curve? Explain.
50. The Phillips curve and the short-run aggregate supply curve are closely related, yet one slopes
downward and the other slopes upward. Discuss.
8678 The Short-Run Trade-off between Inflation and Unemployment
51. Explain the connection between the vertical long-run aggregate supply curve and the vertical long-
run Phillips curve.
52. Suppose that the Fed unexpectedly pursues contractionary monetary policy. What will happen to
unemployment in the short run? What will happen to unemployment in the long run? Justify your
answer using the Phillips curves.
The Short-Run Trade-off between Inflation and Unemployment 8679
53. What did Friedman and Phelps predict would happen if policymakers tried to move the economy
upward along the Phillips curve? Did the behavior of the economy in the late 1960s and the 1970s
prove them wrong?
54. Some countries have inflation around or in excess of 8 percent. Suppose that the sacrifice ratio is
2.5. What is the cost of reducing inflation from 8 percent to 2 percent? In your answer, define the
sacrifice ratio and explain how you found the cost of inflation reduction.
8680 The Short-Run Trade-off between Inflation and Unemployment
55. Why does a downward-sloping Phillips curve imply a positive sacrifice ratio?
56. Suppose that the economy is at an inflation rate such that unemployment is above the natural rate.
How does the economy return to the natural rate of unemployment if this lower inflation rate
persists? Use sticky-wage theory to explain your answer.
The Short-Run Trade-off between Inflation and Unemployment 8681
57. Some economists argue suddenly reducing money supply growth is a costly way to reduce
inflation and that it may not work. For example, if a government cuts money growth but makes no
real fiscal reforms, people will expect the government will eventually need to expand the money
supply to pay for its expenditures. Thus, the promise to fight inflation will not be credible. Explain
why credibility is important to a reduction in the inflation rate.
8682 The Short-Run Trade-off between Inflation and Unemployment
58. Some countries have had relatively high inflation and relatively high unemployment for long periods
of time. Is this consistent with the Phillips curve? Defend your answer.
The Short-Run Trade-off between Inflation and Unemployment 8683
59. Suppose that the Prime Minister and Parliament of Veridian are disappointed with the high
inflation rates under the current system where the Veridian Ministry of Finance is in charge of the
money supply. They make reforms to lower inflation from its current rate of 8%. Suppose further
that the public is confident that with the reforms in place that inflation will fall to 2%. Also
suppose that those in control of the money supply actually conduct monetary policy so that the
actual inflation rate is 4%. Using long-run and short-run Phillips curves and assuming the natural
rate of unemployment is 6%, show the initial long run equilibrium of Veridian and label it “A”.
Assuming that the government had actually set inflation at 2% and that the public believed this,
label the long-run equilibrium “B”. Now, suppose that inflation expectations fell to 2% and that
the government unexpectedly created inflation of 4%. Show the short-run equilibrium and label it
“C”. If the money supply continues to grow at a rate consistent with 4% inflation, show where the
economy ends up and label that point “D”.
