A country's central bank maintains a long-term inflation target of 2%. A severe drought causes a sharp, temporary increase in food prices, pushing the overall current inflation rate to 6% for one year. During this period, data from financial markets and surveys of businesses show that most people expect inflation to return to 2% in the following year, and long-term wage contracts continue to be negotiated with pay increases that reflect a 2% inflation assumption. Which of the following statements best analyzes this economic situation?

Evaluating Economic Stability

The Role of Expectations in Price Stability

Stability of Future Price Beliefs

In an economy, a sudden and significant increase in global oil prices causes the current inflation rate to rise sharply. If wage and price setters immediately begin demanding higher long-term wage increases and raising prices in anticipation of sustained high inflation, this indicates that their inflation expectations are well-anchored.

Match each economic observation with the state of inflation expectations it most likely indicates.

When a temporary economic shock, such as a sudden rise in energy prices, causes a brief spike in current inflation but does not significantly alter the public's long-term view of future price levels, inflation expectations are said to be ________.

An economy with a credible central bank and a 2% inflation target experiences a sudden, temporary disruption to its supply chains. Arrange the following events in the logical sequence that would demonstrate that inflation expectations are well-anchored.

Evaluating Economic Stability

Central Bank Policy Dilemma