Assume that expected inflation follows the second case covered in class What inflatio...........

Economics- Phase (I & II) Inflation and Phillips Curve

Assume that expected inflation follows the second case covered in class What inflation level is consistent with the government maintaining output below the natural level.

Positive Inflation

Negative Inflation

Zero Inflation

All of the above

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Explanation:

With the given form of expected inflation, the modified (a.k.a. expectation augmented) Phillips Curve slopes downward. Recall that unlike the Phillips Curve, which has inflation on the axes, the modified Phillips Curve instead has change in inflation. Tracing along the modified Phillips Curve, when output below natural level, inflation is decreasing. However, this has no implication on the actual level of inflation. Inflation could have been decreasing from 10 to 8, from 2 to 0, or from 0 to -2. Hence a,b,c are all possible levels of inflation.