Question

An economy has the natural rate of unemployment equal to 9.2%. The inflation rate in the previous period was 5% If there is no cyclical unemployment and the country has adaptive expectations what is the difference between the inflation rate and the expected inflation rate.

Answer 1

In case of Adaptive expectations, the expectation about the current year's inflation rate are based on the previous year inflation rate.

Formula of adaptive expectations is Pe = Pt - 1

Thus, in the case of adaptive expectations, expected inflation rate is equal to the actual inflation rate of previous period.

Expected inflation rate = previous period inflation rate = 5%.

Hence, the difference between the inflation rate and the expected inflation rate is equal to zero in this case.