Question

.Why is the anchored inflation expectations not sustainable in an economy where rate of unemployment remains below the (not so much) natural rate of unemployment? Explain.

Answer 1

Inflation expectations play a vital role in the actual level of inflation, because individuals incorporate their expectations on inflation when making price-setting decisions or when bargaining for wages. An unemployment rate below the natural rate indicates that the economy of the country is growing faster than its maximum sustainable rate, thus as a result putting upward pressure on prices and wages in general leading to increased inflation. The economy runs the risk of inflation and is known as to be the non-accelerating inflation rate of unemployment. Consequently the anchored inflation expectations are not sustainable in an economy.