You are watching the evening news on television. The news anchor reports that union wage demands are much higher this year because the workers anticipate an increase in the rate inflation. Your roommate says, "Inflation is a self- fulfilling prophecy. If workers think there are going to be higer prices, they demand higher wages. This increases the cost of production and firms raises their prices. Expecting higher prices simply causes higher prices".
1. Is this is true in the short run? Explain.
2. If policymakers do nothing and allow the economy to adjust to the natural rate of output on its own, does expecting higher prices cause higher prices in the long run? Explain.