What will happen if policymakers erroneously believe that the natural rate of un

Question

What will happen if policymakers erroneously believe that the natural rate of unemployment is 7%, when it is actually 5%, and pursue stabilization policy? 0 A. Policymakers will likely pursue contractionary policy, which could lead to deflation and a severe economic downturn. O B. Policymakers will definitely pursue expansionary policy, which will help to reduce the unemployment rate. ° C. Policymakers will provide a fiscal stimulus package to lower the unemployment rate and increase aggregate demand. O D. Policymakers will leave autonomous monetary policy unchanged, relying on the self-correcting mechanism.

Explanation / Answer

Since actual unemployment is less than natural rate of unemployment which means there is excess employment or it means actual GDP is greater than potential GDP.

Thus there is inflationary gap, which make policy maker to induce contractionary policy.

Thus ans is A

Policymaker will pursue contactionary fiscal amd monetary policy which will reduce aggregate demand and expenditure which will deflate the economy and thus a severe economic downturn.

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