Practice question · Multiple choice
Stagflation combined high inflation with high unemployment, which the Phillips curve said could not persist. Why was that a crisis for the theory and not just a bad decade?
Hints
- Ask what happens when people start ANTICIPATING the inflation policy creates.
- A relationship can hold in data and break when it is used.
Show the answer
D. Because the trade-off shifted once expectations adjusted
Why
This is the Lucas critique in the wild: a correlation exploited by policy stops holding, because the behaviour producing it adapts to the policy.
Practise Oil Shocks and Stagflation
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