{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

Expected_Inflation - :TheWedgeApproach interestrate:i=r e.

Info icon This preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
Expected Inflation and the IS Curve:  The Wedge Approach When expected inflation is not zero there is a difference between the nominal and real  interest rate:  i = r +  π e .  Notice that expected inflation puts a “wedge” between nominal  and real interest rates in much the same way that sales taxes and subsidies put a wedge  between the price the consumer pays, P C , and the price the firm receives, P F .  P C  = P F sales tax; P C  = P F - subsidy.  I think a convenient way to analyze expected inflation and  changes in expected inflation is to use the wedge approach similar to the analysis of  Figures 6-8 and 6-9 in Mankiw’s principles text.  The trick is to realize that the vertical  axis measures both the nominal and real interest rates;  the nominal interest rate is  determined by the central bank, but the real interest rate is what matters for the IS curve.  Equilibrium occurs at the one value of Y, at which the nominal and real interest rates  differ by the expected rate of inflation (i-r =  π e ).  The graphs below show a short-run  equilibrium in an economy with positive expected inflation on the left and negative 
Image of page 1

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern