Discuss the unemployment consequences of reducing inflation

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Reference no: EM131141922

Suppose the economy is at full employment but inflation is viewed as too high. Consider the following two scenarios:

(a) The central bank has great credibility. The central bank announces a policy of disinflation, and the public believes the announcement. Inflationary expectations fall immediately.

(b) The central bank has no credibility. The central bank announces a policy of disinflation but the public is skeptical that the bank will actually follow through with it. The public's inflationary expectations fall only if they see actual inflation coming down. Discuss the likely unemployment consequences of reducing inflation in each of these two scenarios. In which case will the sacrifice ratio (the unemployment cost of reducing inflation) be higher? Explain why.

Reference no: EM131141922

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