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True or false:  One way to explain the apparent trade off between inflation and...

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lilylee | Student, College Freshman | (Level 1) Salutatorian

Posted July 25, 2013 at 2:25 PM via web

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True or false:  One way to explain the apparent trade off between inflation and unemployment during the 1960s is that expected inflation was consistently higher than the actual inflation implying that firms would be willing to hire more workers given this difference between expected and actual inflation. The result therefore would be higher inflation and lower unemployment, consistent with the facts during the 1960s.

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted July 26, 2013 at 2:13 AM (Answer #1)

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This statement is not true.  If firms and workers expected higher rates of inflation than actually occurred, the firms would not have been likely to hire more workers.  If anything, they would have hired fewer workers.

If a firm and its workers expect a given rate of inflation, they will probably agree on wage increases to match the rate of inflation.  If, for example, they expect that inflation will be 4%, they will probably give the workers raises of at least 4%.  Now let us think about what happens if the rate of inflation is actually 2%.  In that case, the firm is paying more than it should be for its labor.  It will not be able to afford this year after year.  If it is consistently paying wages that are too high, it is not going to go out and hire still more workers and these excessive wages. 

If expected inflation is consistently above actual inflation, it is more likely that firms will hire fewer workers.  Because of this, this statement is false.

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