Consider an economy with ongoing inflation with backward-looking expectations, πTE(t) = π(t-1), where (t) is the expected inflation rate at time t and π(t-1) is actual inflation at time t-1. The augmented Phillips curve PC (t) written in terms of output gaps is π(t) = π²(t) + a (y(t) - ye ) where a > 0 is a constant, y(t) is output at time t, and ye is potential output. The economy at time t = 0 is in point A in the figure below: inflation is (0) and output is equal to y(o), strictly below potential output. The Central Bank knows the Phillips curve and is able to decide output in all future periods (t = 1,2,...). TU (1) PC(0) A TT (0) πτ y(t) y(0) ye The Central Bank would like to induce an inflation rate T in the medium run and considers two alternative strategies: Strategy I. Keep output at the initial level y(o) until inflation reaches T and stabilize the economy from that point onwards. Strategy II. Induce a series of gradual increases in output until inflation reaches and output is stabilized. Answer all the following questions.
Consider an economy with ongoing inflation with backward-looking expectations, πTE(t) = π(t-1), where (t) is the expected inflation rate at time t and π(t-1) is actual inflation at time t-1. The augmented Phillips curve PC (t) written in terms of output gaps is π(t) = π²(t) + a (y(t) - ye ) where a > 0 is a constant, y(t) is output at time t, and ye is potential output. The economy at time t = 0 is in point A in the figure below: inflation is (0) and output is equal to y(o), strictly below potential output. The Central Bank knows the Phillips curve and is able to decide output in all future periods (t = 1,2,...). TU (1) PC(0) A TT (0) πτ y(t) y(0) ye The Central Bank would like to induce an inflation rate T in the medium run and considers two alternative strategies: Strategy I. Keep output at the initial level y(o) until inflation reaches T and stabilize the economy from that point onwards. Strategy II. Induce a series of gradual increases in output until inflation reaches and output is stabilized. Answer all the following questions.
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
Related questions
Question
-
Discuss the general implications of pursuing strategy I versus strategy II, emphasizing what would be, in your view, the “positive” and the “negative” aspects of each strategy
-
Under what type of Central Bankp references would strategy II be the optimal strategy? Can strategy I be the optimal strategy assuming a different type of Central Bank preferences?
Transcribed Image Text:Consider an economy with ongoing inflation with backward-looking
expectations, ²(t) = π(t-1), where π(t) is the expected inflation rate at time t
and π(t-1) is actual inflation at time t-1. The augmented Phillips curve PC(t)
written in terms of output gaps is
π(t) = π²(t) + a (y(t) - ye )
where a > 0 is a constant, y(t) is output at time t, and ye is potential output. The
economy at time t = 0 is in point A in the figure below: inflation is (0) and
output is equal to y(0), strictly below potential output. The Central Bank knows
the Phillips curve and is able to decide output in all future periods (t = 1,2,...).
TT (1)
PC(0)
A
TT
-y(t)
y(0)
The Central Bank would like to induce an inflation rate T in the medium run
and considers two alternative strategies:
Strategy I. Keep output at the initial level y(o) until inflation reaches ¹
and stabilize the economy from that point onwards.
Strategy II. Induce a series of gradual increases in output until inflation
reaches and output is stabilized.
Answer all the following questions.
T(0)
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
This is a popular solution!
Trending now
This is a popular solution!
Step by step
Solved in 2 steps
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, economics and related others by exploring similar questions and additional content below.Recommended textbooks for you
Principles of Economics (12th Edition)
Economics
ISBN:
9780134078779
Author:
Karl E. Case, Ray C. Fair, Sharon E. Oster
Publisher:
PEARSON
Engineering Economy (17th Edition)
Economics
ISBN:
9780134870069
Author:
William G. Sullivan, Elin M. Wicks, C. Patrick Koelling
Publisher:
PEARSON
Principles of Economics (12th Edition)
Economics
ISBN:
9780134078779
Author:
Karl E. Case, Ray C. Fair, Sharon E. Oster
Publisher:
PEARSON
Engineering Economy (17th Edition)
Economics
ISBN:
9780134870069
Author:
William G. Sullivan, Elin M. Wicks, C. Patrick Koelling
Publisher:
PEARSON
Principles of Economics (MindTap Course List)
Economics
ISBN:
9781305585126
Author:
N. Gregory Mankiw
Publisher:
Cengage Learning
Managerial Economics: A Problem Solving Approach
Economics
ISBN:
9781337106665
Author:
Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor
Publisher:
Cengage Learning
Managerial Economics & Business Strategy (Mcgraw-…
Economics
ISBN:
9781259290619
Author:
Michael Baye, Jeff Prince
Publisher:
McGraw-Hill Education