Consider an economy with ongoing inflation with backward-looking expectations, πTE(t) = π(t-1), where (t) is the expected inflation rate at time t and π(t-1) is actual inflation at time t-1. The augmented Phillips curve PC (t) written in terms of output gaps is π(t) = π²(t) + a (y(t) - ye ) where a > 0 is a constant, y(t) is output at time t, and ye is potential output. The economy at time t = 0 is in point A in the figure below: inflation is (0) and output is equal to y(o), strictly below potential output. The Central Bank knows the Phillips curve and is able to decide output in all future periods (t = 1,2,...). TU (1) PC(0) A TT (0) πτ y(t) y(0) ye The Central Bank would like to induce an inflation rate T in the medium run and considers two alternative strategies: Strategy I. Keep output at the initial level y(o) until inflation reaches T and stabilize the economy from that point onwards. Strategy II. Induce a series of gradual increases in output until inflation reaches and output is stabilized. Answer all the following questions.

Consider an economy with ongoing inflation with backward-looking expectations, πTE(t) = π(t-1), where (t) is the expected inflation rate at time t and π(t-1) is actual inflation at time t-1. The augmented Phillips curve PC (t) written in terms of output gaps is π(t) = π²(t) + a (y(t) - ye ) where a > 0 is a constant, y(t) is output at time t, and ye is potential output. The economy at time t = 0 is in point A in the figure below: inflation is (0) and output is equal to y(o), strictly below potential output. The Central Bank knows the Phillips curve and is able to decide output in all future periods (t = 1,2,...). TU (1) PC(0) A TT (0) πτ y(t) y(0) ye The Central Bank would like to induce an inflation rate T in the medium run and considers two alternative strategies: Strategy I. Keep output at the initial level y(o) until inflation reaches T and stabilize the economy from that point onwards. Strategy II. Induce a series of gradual increases in output until inflation reaches and output is stabilized. Answer all the following questions.

MACROECONOMICS FOR TODAY

10th Edition

ISBN:9781337613057

Author:Tucker

Publisher:Tucker

Chapter17: The Philips Curve And Expetactions Theory

Section: Chapter Questions

Problem 1SQP

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