Macropoland has a natural rate of unemployment at about 4.5% and its long run average of inflation

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Question:

Macropoland has a natural rate of unemployment at about 4.5% and its long run average of inflation over time has been about 2%. This means that no matter what happens in the short run, the long-run averages of unemployment and inflation will always be about 4.5% and 2%. During the time period 1973-1974, the unemployment and inflation rates both rose significantly. In present time, the inflation rate is lower than the long-run average inflation rate, and the unemployment rate is greater than the natural rate. Changes during these different time periods may be explained using aggregate supply and aggregate demand curves.

During the time period 1973-1974, Macropoland went through a deep recession where the value of their dollar rose and output increased. The inflation rate caused a general rise in the price level, which consequently caused the demand curve to move to the right. This means that the prices of items will increase and consequently people will demand less of each item. In addition, the unemployment rate increased which could be due to a decrease in the output needed. When the output rate falls below the natural rate of output, the employment rate suffers as seen in Macropoland.

In present time, the unemployment rate is at 9% and the inflation rate is at .4%. Macropoland is also experiencing very sluggish consumption and investment due to a fall in the housing market. The fall in the housing market caused the price level to fall below the expected price level and caused the rate of output to fall below the natural rate of output. This caused the unemployment rate to rise above the natural rate of unemployment in the short run.

According to aggregate demand and aggregate supply, while the price level may change, the unemployment and inflation rate will always return to their natural rates. Different events may trigger short-run changes but these changes will always return to their natural rate in the long run. The present inflation and unemployment rates should eventually return closer to their natural rates because short-run effects are different from long-run effects.