Use the information below to explain adjustments that move the economy to a long-run equilibrium. Assume that firms and workers have adaptive expectations
The current unemployment rate = 4%.
The natural rate of unemployment = 6%.
Last year's inflation rate = 3%.
This year's inflation rate = 4%.
If firms and workers have adaptive expectations, they will expect inflation this year to be the same as last year (3%). Since workers are underestimating the actual rate of inflation, real wages will be declining, leading to an unemployment rate that is below its natural level (4% < 6%). As firms and workers adjust their inflation expectations, real wages will increase until the economy reaches its natural rate of unemployment.
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