Question

If asset prices fall and inflation expectations remain unchanged, what happens to inflation and unemploy

Answer 1

And. Fall in asset prices causes the interest rate to rise which leads to increase in cost of borrowing. This reduces business and residential investment decreasing aggregate demand for goods and services. This decreases price level (decrease in inflation) in the economy and decreases equilibrium output.

Philips curve gives the relation between inflation and unemployment as,

Actual inflation - expected inflation = -a*(actual unemployment - natural rate of unemployment)

where a = proportionality constant

So, according to the philips curve equation, a decrease in inflation keeping expected inflation unchanged leads to an increase in unemployment rate (as output has decreased, so, labor required to produce that output will also decrease)

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