Purdue ECON 352 PS4 - ECON 352 Intermediate Macroeconomics...

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ECON 352 Intermediate MacroeconomicsPurdue UniversityProblem Set 4Soojin KimSpring 2015Due beginning of class on April 23 (Thursday)1.Short-Run Phillips CurveAssume that an economy is governed by the Phillips curve:π=-0.5(u-0.06),whereπis the inflation rate,is the expected inflation rate, and the natural rate ofunemployment is 6%. Also, note from Okun’s law that 1 percentage point of unemploymenttranslates into 2 percentage points of lost output.Suppose that today,π= 0.05 and= 0.05. The government wants to lower inflation to2%.Assume that people have adaptive expectations.(a) How muchcyclicalunemployment does the economy have to experience to have inflationrate of 2%?(b) What is the sacrifice ratio?Assume that the government announced its plans to lower inflation before theworkers and firms form their expectations.The workers and firms form theirexpected inflation by the following rule:=απa+ (1-α)π-1,whereπ-1is the inflation rate in the previous period,πais the announced inflation,and
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Exploring Economics
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