levels of inflation, with no long-run improvement in unemployment, thus contradicting the opinions of those who advocate the use of government policy action to influence the level of unemployment in an inflationary environment.
12.2 Policy Implications
Several interesting policy considerations stem from the theory that there is no long-run trade-off between inflation and unemployment:
1. Reducing the NRU. In the long run unemployment can be reduced only by lowering the NRU. Government policy in this regard takes the form of alleviating imperfections in the labor market: labor retraining programs; programs to increase labor market information or reduce the cost of obtaining such information; programs to increase labor mobility; elimination of minimum-wage legislation; restructuring of welfare and unemployment insurance programs; and fiscal policy to reduce demand in geographic or industry bottlenecks.
2. The accelerationist hypothesis. By accelerating the inflation rate, the government may continually fool labor and outstrip contracts, lowering unemployment permanently below its natural rate. This possibility reflects the accelerationist hypothesis that the relevant trade-off is between unemployment and accelerating inflation rather than between unemployment and inflation. In this context, the natural rate of unemployment is sometimes called the nonaccelerating-inflation rate of unemployment (NAIRU). This terminology suggests that if a central bank tried to reduce the unemployment rate below the NRU (because it underestimated the NRU, for example), it could be led to increase the money supply at an excessive rate.
3. Policy ineffectiveness debate. In our modern society information is communicated rapidly and interpreted with sophistication. An increase in the rate of growth of the money supply soon becomes widely known, and the new, higher rate of inflation it implies quickly becomes anticipated. If people form their expectations of future values of economic variables by working through the appropriate economic theory in conjunction with the best available information, they are said to produce rational expectations. Such expectations should be much more accurate than expectations formed by ignoring current information on relevant economic variables and simply extrapolating past values of the variable to be forecast.
In the example of figure 12.2, if people form their expectations of inflation rationally, when the higher money-supply growth rate becomes known the inflation of position D is expected. This analysis suggests that SRPC shifts immediately up to SRPC' and the economy moves directly to D, without taking the path through C. It thus appears that if expectations are formed rationally, even the short-run trade-off disappears. According to this thinking, once we are at the NRU, any systematic policy is completely
