If policymakers try to push unemployment below the NAIRU in the long run, what happens?

• A. Inflation accelerates and unemployment returns to NAIRU
• B. Unemployment stays below NAIRU
• C. Inflation accelerates and unemployment rises forever
• D. No effect on inflation

Answer: (A)

The idea being tested is that in the long run the unemployment rate tends to settle at the NAIRU, and trying to push it below that level is unsustainable. The NAIRU is the unemployment rate where inflation doesn’t keep accelerating; the long-run Phillips curve is effectively vertical at that rate. When policymakers push unemployment below the NAIRU, they boost demand and temporarily lower unemployment, but this creates higher inflation and higher inflation expectations. As wages and prices adjust, those expectations get built into the economy, eroding the real effects of the stimulus, and unemployment moves back up toward the NAIRU. In this process, inflation accelerates, but unemployment does not stay below the NAIRU in the long run. So the outcome is that inflation accelerates while unemployment returns to the NAIRU.