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ECON 305: INTERMEDIATE MACROECONOMICS SPRING 2008 MARK MOORE PROBLEM SET 5: SOLUTIONS CHAPTER 8 Quick Check 1. a. True. b. False. c. False, as long as expectations are included in the AS relation. d. True. e. False. f. True. 2. a. No. In the 1970s, we experienced high inflation and high unemployment. The expectations-augmented Phillips curve is a relationship between inflation and unemployment conditional on the natural rate and inflation expectations. Given inflation expectations, increases in the natural rate (which result from adverse shocks to labor market institutions—increases in z—or from increases in the markup—which encompass oil shocks) lead to an increase in both the unemployment rate and the inflation rate. In addition, increases in inflation expectations imply higher inflation for any level of unemployment. (Increases in inflation expectations also tend to increase the unemployment rate in the short run from the supply side— think of an increase in the expected price level, given last period’s price, in the AD-AS framework. However, increases in inflation expectations may tend to increase short run output from the demand side, because of the real interest rate effect. The real interest rate is introduced in Chapter 14.) In the 1970s, both the natural rate and expected inflation increased, so both unemployment and inflation were relatively high. b. No. The expectations-augmented Phillips curve implies that maintaining a rate of unemployment below the natural rate requires increasing (not simply high) inflation. This is because inflation expectations continue to adjust to actual inflation. 3.
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This note was uploaded on 09/14/2008 for the course ECON 305 taught by Professor Dekle during the Spring '07 term at USC.

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