IAI Actuarial Core Principles · Business Economics · Business activity, unemployment and inflation
Which statement best describes the long-run Phillips curve in monetarist and new classical theory?
The long-run Phillips curve is vertical at the natural rate of unemployment. Because expectations fully adjust over time, unemployment returns to its natural level regardless of the inflation rate, so there is no permanent trade-off. It is not vertical at zero inflation.
- AIt is vertical at the natural rate of unemploymentCorrect
- BIt is horizontal at the prevailing inflation rate
- CIt is downward sloping with a steeper gradient than in the short run
- DIt is upward sloping because of wage rigidity
- It is vertical at zero inflation
Explanation
In the long run, expectations fully adjust, so unemployment returns to the natural rate whatever the inflation rate. This makes the long-run curve vertical at the natural rate, not at zero inflation, and there is no permanent trade-off.
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