Question

1. Inflation and unemployment. Suppose that the Phillips curve is given by: TI= +0.1 - 2ut where = 077-1. Also, suppose that is initially equal to zero. (a) What is the natural rate of unemployment? 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 3% and hold it there forever. (b) Determine the rate of inflation in years t, t+1, t +2, + +10, t+15. (c) Do you believe the answer you gave in (b)? Why, or why not? (Hint: Think about how inflation expectations are formed.) Now, suppose that in year t + 5, 6 increases from 0 to 1. (d) Why might increase like this? What is the effect on un? Suppose that government is still determined to keep u at 3% forever. (e) What will the inflation rate be in years t +5, t +10, and t +15? (f) Do you believe the answer given in (e)? Why, or why not?

Answer 1

As per HOMEWORKLIB RULES, experts are only obligated to answer first 4 parts if there are multiple subparts to a question, rest are optional. Kindly post remaining parts.

a. π^et = π t  and theta =0, then

π^et - π t = 0.1 - 2u_t

0= 0.1 - 2u_t

U_t = 0.05% or 5%

b. As theta is zero, inflation rate will stay the same in every period πt=0.1- 2(0.03)=4%

c. I don't believe it as expected inflation will always be wrong for each year which is absurd.

d. Theta might increase this way because of inflation expectation as expected inflation depends on actual inflation but there will be no effect on u_n..