Question

The expected inflation rate is 5 percent, and the actual inflation rate is 7 percent. According to Friedman, is the economy in long-run equilibrium? Explain your answer.

Short answer

No, the economy is not in long-run equilibrium. This is because, according to Friedman, an economy attains long-run equilibrium when the actual inflation rate equals the expected inflation rate. In this scenario, the actual rate of 7 percent is higher than the expected rate of 5 percent, suggesting that the economy is not in a state of long-run equilibrium.

Step-by-step solution

Understanding the Concepts

Friedman's theories are tied to the concept of long-run equilibrium in an economy. An economy is in long-run equilibrium when actual inflation equals expected inflation. In other words, the rate at which prices increase (actual inflation) is the same as what people think it will be (expected inflation). If the actual inflation is different from expected inflation, the economy is said to be out of long-run equilibrium.

Examine Given Data

In the situation presented, the expected inflation rate is 5 percent and the actual inflation rate is 7 percent. This indicates that the actual inflation rate is higher than what was expected.

Apply Friedman’s Theory

According to Friedman’s theory, for the economy to be in long-run equilibrium, actual inflation must equal expected inflation. But in the given scenario, the actual inflation rate (7 percent) is higher than the expected inflation rate (5 percent). Thus, applying Friedman's theory, it can be concluded that the economy is not in long-run equilibrium.