I. Suppose that the Phillips curve is given by 1 = n + 0.1 – 2u; a. What is the natural rate of unemployment? Assume 7 = On;-1, and suppose that 0 is initially equal to 0. Suppose that the rate of unemployment is initially equal to the natural rate. In year t, the authorities decide to bring the unemployment rate down to 4% and hold it there forever. b. Determine the rate of inflation in years t, t + 1, t + 2, and t + 5. c. Do you believe the answer given in (b)? Why or why not? (Hint: Think about how people are likely to form expectations of inflation.)

I. Suppose that the Phillips curve is given by 1 = n + 0.1 – 2u; a. What is the natural rate of unemployment? Assume 7 = On;-1, and suppose that 0 is initially equal to 0. Suppose that the rate of unemployment is initially equal to the natural rate. In year t, the authorities decide to bring the unemployment rate down to 4% and hold it there forever. b. Determine the rate of inflation in years t, t + 1, t + 2, and t + 5. c. Do you believe the answer given in (b)? Why or why not? (Hint: Think about how people are likely to form expectations of inflation.)

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Question

a, b, c

**Phillips Curve Analysis**

**I. Suppose that the Phillips curve is given by**

\[
\pi_t = \pi_t^e + 0.1 - 2u_t
\]

**a. What is the natural rate of unemployment?**

Assume \(\pi_t^e = \theta \pi_{t-1}\), and suppose that \(\theta\) is initially equal to 0. Suppose that the rate of unemployment is initially equal to the natural rate. In year \(t\), the authorities decide to bring the unemployment rate down to 4% and hold it there forever.

**b. Determine the rate of inflation in years \(t\), \(t + 1\), \(t + 2\), and \(t + 5\).**

**c. Do you believe the answer given in (b)? Why or why not?**
(Hint: Think about how people are likely to form expectations of inflation.)

Now suppose that in year \(t + 5\), \(\theta\) increases from 0 to 1. Suppose that the government is still determined to keep \(u\) at 4% forever.

**d. Why might \(\theta\) increase in this way?**

**e. What will the inflation rate be in years \(t + 5\), \(t + 6\), and \(t + 7\)?**

**f. Do you believe the answer given in (e)? Why or why not?**

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