Consider a version of the Phillips curve where a proportion of wages, 1 >> 0, are nowindexed to the rate of inflation. In these labor contracts, nominal wages move one-for-one withthe actual price level. The remaining proportion of wages, (1-2), are set on the basis ofexpected inflation:nt λnt (1) et+ (m+z)-aut(2)a. Suppose that лet=πt-1. Solve for the natural rate of unemployment (the rate suchthat t=t-1). Is the natural rate of unemployment different as a result of wage indexation?b. Re-write the Phillips curve in terms of the difference between чt and un using thevalue for un you calculated in (a). How does wage indexation impact the way changes ininflation respond to deviations of the unemployment rate from the natural rate? What is theintuition for this result?

The Phillips curve establishes the relationship between inflation in time period t and unemployment…

Consider a version of the Phillips curve where a proportion of wages, 1>>0, are now indexed to the rate of inflation. In these labor contracts, nominal wages move one-for-one with the actual price level. The remaining proportion of wages, (1-2), are set on the basis of expected inflation: nt=λnt + (1) et+ (m+z)-aut (2) a. Suppose that лet=πt-1. Solve for the natural rate of unemployment (the rate such that at nt-1). Is the natural rate of unemployment different as a result of wage indexation? b. Re-write the Phillips curve in terms of the difference between чt and un using the value for un you calculated in (a). How does wage indexation impact the way changes in inflation respond to deviations of the unemployment rate from the natural rate? What is the intuition for this result?

Consider a version of the Phillips curve where a proportion of wages, 1>>0, are now indexed to the rate of inflation. In these labor contracts, nominal wages move one-for-one with the actual price level. The remaining proportion of wages, (1-2), are set on the basis of expected inflation: nt=λnt + (1) et+ (m+z)-aut (2) a. Suppose that лet=πt-1. Solve for the natural rate of unemployment (the rate such that at nt-1). Is the natural rate of unemployment different as a result of wage indexation? b. Re-write the Phillips curve in terms of the difference between чt and un using the value for un you calculated in (a). How does wage indexation impact the way changes in inflation respond to deviations of the unemployment rate from the natural rate? What is the intuition for this result?

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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A policy-maker minimises a loss function of the form: V = [u – (un – k)]² + a(n – n°)² subject to current given conditions for the economy stated as u = un – b(n – n°) + E. Price and wage setters are endowed with rational expectations. Derive the time consistent rate of inflation.
Consider an economy for which wage and price inflation are initially 3% under a zero output gap. Calculate price inflation by the end of the current period under a new output gap of 6%. (Hint: you need to use the Phillips curve equation)
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If inflation is at target, phi = phi* , then actual output must coincide with potential output, Y=Y*. a. True b. False
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If inflationary expectations are increasing, we would expect that the nominal interest rate would also be increasing, holding all else constant. Select one: True False
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The following graph depicts the short-run and long-run Phillips curves (SRPC and LRPC) for a hypothetical economy in long-run macroeconomic equilibrium at point A, where the natural unemployment rate is 6% and the current inflation rate is 8% per year.
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Assume that the price level in an economy is stable with expected inflation initially equal to 3% in period 0. Further assume the economy is then hit by an expansion at the beginning of period 1, and employment remains at a constant high level until the beginning of period 4. With ‘time period’ on the xaxis and ‘inflation rate’ on the y-axis: (i) Plot the path of the bargaining gap (assume it is equal to 1%), inflation and expected inflation from period 1 to the end of period 4. (ii) Provide some reasons for why the bargaining gap might disappear after period 4, and state any other assumptions you are making. (iii) Explain how an increase in the central bank’s policy interest rate would affect the exchange rate through the market for financial assets (such as government bonds). What impact would this have on aggregate demand?
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