In which of the scenarios listed here will the unemployment rate fall below the
ID: 1206784 • Letter: I
Question
In which of the scenarios listed here will the unemployment rate fall below the natural rate of unemployment? There could be more than one answer
A.Inflation is steady at 3% for two years but then decreases to 1% for a year.
B.Inflation is steady at 5% for several years.
C.Inflation is steady for 2% for three years, and the Fed unexpectedly increases the money supply, causing inflation to increase to 3% the following year.
D.Inflation is steady at 1% for three years but then increases to 4% for one year.
Explanation / Answer
When the unemployment rate is below the natural rate of unemployment, inflation rate is rising.
Therefore, for option (D), we observe that steady inflation rate implies NAIRU (non accelerating inflation rate of unemployment) but then it rises to 4% which indicates unemployment has fallen.
Similarly, option (C) also applies. Natural rate of unemployment is 2% and the Fed's increase in money supply not only increases inflation but also the activity level, leading to lowered unemployment. Thus unemployment falls below the natural rate.