Principles of Economics: Problems: Phillips Curve II
In the Phillips Curve framework in which:
π = E(π) + β(u* - u)
the inflation rate π equals the previously- expected inflation rate E(π) plus the “slope” β times the difference between the natural rate of unemployment u* and the actual rate of unemployment u—and in which this year’s expected inflation E(π) is last year’s actual inflation, calculate the rate of inflation π:
In the first year, if the starting E(π)=2% per year, β = 1⁄2,u*=5%, and u=5%
In the second year, if E(π) is what inflation was the previous year—that is, if E(π) is your answer to part a—β = 1⁄2, u = 5%, but structural changes in the economy raise u* to 7%
In the third year, if E(π) is what inflation was the previous year—that is, if E(π) is your answer to part b—β = 1⁄2, u = 5%, but structural changes in the economy keep u* at 7%
In the fourth year, if E(π) is what inflation was the previous year—that is, if E(π) is your answer to part c—β = 1⁄2, u = 5%, but structural changes in the economy keep u* at 7%.
What should the government and central bank do if they want to keep inflation from rising?
