Question

Assume the economy has a natural rate of unemployment of 5%. Graphically illustrate when the actual inflation is 4% and expected inflation is 2%. What will happen to the economy when expected inflation adjust to the actual inflation in the long-run?

Answer 1

It will lead to rise in the cost of raw materials. This rise in prices can also cause greater volatility and uncertainty. therefore, with firms uncertain about future costs, they may hold back from making investment decisions