The effects of a permanent decrease in the rate of nominal
Suppose that the economy can
be described by the following
ut - ut-1 = -0.41gyt - 3%2 Okun's law
pt - pt-1 = -1ut - 5%2 Phillips curve
gyt = gmt - pt Aggregate demand
a. Reduce the three equations to two by substituting gyt from
the aggregate demand equation into Okun's law. (Okun's
law was presented in Chapter 2.)
Assume initially that ut = ut-1 = 5%, gmt = 13%, and
pt = 10%.
b. Explain why these values are consistent with the statement
"Inflation is always and everywhere a monetary
Now suppose that money growth is permanently reduced
from 13% to 3%, starting in year t.
c. Compute (using a calculator or a spreadsheet program) unemployment
and inflation in years t, t + 1, c, t + 10.
d. Does inflation decline smoothly from 10% to 3%? Why or
e. Compute the values of the unemployment rate and the inflation
rate in the medium run.
f. Is the statement that "Inflation is always and everywhere a
monetary phenomenon" a statement that refers to the medium
run or the short run?