Policy Path to Restore Inflation Target with Unanchored Expectations
When inflation expectations become unanchored and rise (as at point D in Figure 5.14), a central bank must pursue a costly, multi-stage policy to restore its inflation target. The process begins with a significant interest rate hike to shift the aggregate demand curve downward, which induces a recession and pushes employment to a level below the new supply-side equilibrium (point F). This period of higher-than-equilibrium unemployment is necessary to bring inflation back down to the target. Once the target is reached, the central bank can then relax its monetary policy, allowing employment to recover to the new, sustainable equilibrium level (point C), where inflation is stable at the target.
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Introduction to Macroeconomics Course
Ch.5 Macroeconomic policy: Inflation and unemployment - The Economy 2.0 Macroeconomics @ CORE Econ
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