Disinflationary Process from a Sustained Recessionary Shock
When a negative aggregate demand shock is sustained, it can initiate a disinflationary process. As workers and consumers observe a lower inflation rate (e.g., 2%), they revise their future inflation expectations downward to align with this recent experience. This reduction in expected inflation causes the entire Phillips curve to shift down. Consequently, in the next period, the same level of cyclical unemployment leads to an even lower inflation rate (e.g., 1%). This cycle of falling expectations, downward-shifting Phillips curves, and declining inflation continues as long as demand remains depressed, which can be depicted as a movement from point C to D to E in related diagrams.
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Introduction to Macroeconomics Course
Ch.4 Inflation and unemployment - The Economy 2.0 Macroeconomics @ CORE Econ
The Economy 2.0 Macroeconomics @ CORE Econ
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Ch.5 Macroeconomic policy: Inflation and unemployment - The Economy 2.0 Macroeconomics @ CORE Econ
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Match each component of the disinflationary process that follows a sustained negative demand shock with its correct description.
In the disinflationary process that follows a sustained negative demand shock, the observed lower rate of price increases causes individuals and firms to revise their ____ downward, which is the direct cause of the downward shift in the short-run Phillips curve.
An economy experiences a persistent and severe decline in aggregate demand, leading to a prolonged recession. The central bank, expecting a rapid self-correction, decides not to intervene with expansionary policy. In the first year of the recession, the inflation rate falls from its stable rate of 3% down to 1%. Given the sustained nature of the recession and the central bank's inaction, what is the most likely outcome for the inflation rate in the following year?
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