Question

4. Suppose that the Phillips curve is given by TT, = 1 + 0.1 - 2u a. What is the natural rate of unemployment? Assume that expected inflation is given by m = (1 - 0) +010-1 And suppose that is initially equal to zero and it is given and does not change. It could be zero or any positive value. Suppose that the rate of unemployment is initially equal to the natural rate. In yeart, the authorities decide to bring the unemployment rate down to 3% and hold it forever. b. Determine the rate of inflation in periods 1+1, 1+2, 1+3, +4.+5. c. Do you believe the answer given in (b)? Why or why not? (Hint: think about how people are more likely to form expectations of inflation). Now suppose that in year 1+6, increases from 0 to 1. Suppose that the government is still determined to keep up u at 3% forever. d. Why 0 might increase in this way? e. What will the inflation rate be in years 1+6, 1+7, and 1+8? = 1 and unemployment is kept below the natural rate of f. What happens to inflation when unemployment? g. What happens to inflation when 0 = 1 and unemployment is kept ay the natural rate of unemployment?

i only need question 5, thanks

Answer 1

Q5)

a) s) t = the toy-QUt a te=1Tt-1 nt-1=0, ut = 4%. It = oto1-2 (004)= a4-.08= .02 = 2% TH= Tt to I-21:04) = 2+2 = 4% To+2= itt tal-21•04)= 6% T +3 = TH&t. 1-2(004) = 8% Ang Ang Wage Contract Indexation Let A prop" of Labor contracts, that are indexed, t = [ht + (1-2) a tel- & (Ut-UN) - put nte= Tt I 80 T-^ht - (1-7) Tt-1 = -x10t-UN)

80 (1-2) [ ñt - Tt-1] = -21Ut-ON), Page No : C) Thus New PC Tt-it-y= -d Cut-UN) (1x). T Now 15:5, UN = .1/9 = 105, as Tt-nte = ol - 20t. = -2(0+ - 08/2). = -2107 - .05) 80 x=2 thus Tt - Tt-1 = -2 (Ot-UN). 80 It-To- =-4 ( Ut -:05) = .2-4U - So. Tt-it1= .2-40) T-1=0, Ut= .04, thus Tt=.2 .16 = 4% Tot i = 4+ 4 =8% nt + 2 = 8+4= 12%, iba Te +z = 12+ 4 = 16%. 2 Ang due to wage indexation, the relation b/w π & u gets Stronger, BLOQ for every un amp. rate, Inflation rate rises