MacroeconomicsChapter 8__2and_7

MacroeconomicsChapter 8__2and_7 - However increases in...

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ANSWERS TO END-OF-CHAPTER PROBLEMS CHAPTER 8 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, when the natural rate of unemployment increases (i.e., when there is an increase in z or μ ), there is also an increase in both the actual unemployment rate and the inflation rate. In addition, increases in inflation expectations imply higher inflation for any level of unemployment. In the 1970s, both the natural rate and expected inflation increased, so both unemployment and inflation were relatively high. Note that 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.
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Unformatted text preview: 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. b. No. The expectations-augmented Phillips curve implies that maintaining a rate of unemployment below the natural rate requires not merely high inflation but increasing inflation. This is because inflation expectations continue to adjust to actual inflation. 7. a. α =1: u u =6%; α =2: u u =3% As wages become more flexible, more of the effect of supply shocks (changes in μ and z ) is transmitted to changes in wages and less to changes in the natural rate of unemployment. b. α =1: u u =9%; α =2: u u =4.5% In an environment with more wage flexibility (higher α ), the natural rate of unemployment rises less in response to an increase in the price of oil. 133...
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