J. Bradford DeLong
What happens if a central bank decides to ease up on inflation--to try to run a lower level of unemployment for each possible level of inflation?
With adaptive expectations, easing policy generates a boom for a while: unemployment declines and GDP rises.
But then inflation picks up. And each increase in inflation calls forth a concommitant upward shift in the short-run Phillips curve because this year's actual inflation is next year's expected inflation.
In the long run unemployment returns to its natural rate, GDP returns to potential, and the only long-run effect of the easing of monetary policy is a permanent jump in inflation.
|The Monetary Policy Reaction Function Easing Policy--Adaptive Expectations Easing Policy--Rational Expectations|
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