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Phillips Curve and Discretionary Policy
1. Phillips Curve:
a) If the equation for a country's Phillips curve is p = 0.02 – 0.7(u – 0.055), where p is the rate of inflation and u is the unemployment rate, what is the short-run inflation rate when unemployment is 5.8 percent (0.058)?
b) Assume that an economy has adaptive expectations with a Phillips curve p = p –1 – 0.4(u – 0.06). How many percentage points and years of cyclical unemployment are needed to reduce inflation by 2 percentage points?
c) Describe the difference in assumptions between Adaptive Expectations and Rational Expectation? How does this difference impact the Federal Reserve Bank’s ability to reduce inflation?
2. Discretionary Policy: (True or False) Monetary policy has a shorter inside time lag than fiscal policy while it has a longer outside lag than fiscal policy. (In your explanation specifically describe the lags in each policy)
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