Chapter 24: Q. 20 (page 655)
What will happen if policymakers erroneously believe that the natural rate of unemployment is 7% when it is actually 5% and therefore pursue stabilization policy?
The economy will experience deflation and a severe slump, causing inflation to spiral lower.
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Activists regard the self-correcting mechanism, which works through wage and price adjustment, as very slow and hence feel that the government should pursue active, accommodating policy to address high unemployment when it develops. Nonactivists, by contrast, believe that the self-correcting mechanism works quickly and therefore advocate that the government should avoid the implementation of active policies aimed at eliminating unemployment.
“If the data and recognition lags could be reduced, activist policy probably would be more beneficial to the economy.” Is this statement true, false, or uncertain? Explain your answer.
Because government policymakers do not consider inflation desirable, their policies cannot be the source of inflation.” Is this statement true, false, or uncertain? Explain your answer.
Use a graph of aggregate demand and supply to demonstrate how lags in the policy process can result in undesirable fluctuations in output and inflation.
During the global financial crisis, how was the Fed able to help offset the sharp increase in financial frictions without the option of lowering interest rates further? Did the Fed’s plan work?
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