Reference no: EM13106783
Suppose that the Phillips curve is given by:
Πt = Πet - (Πt - 5%)
and expected inflation is given by
Πet = Πt-1
a. What is the sacrifice ratio in this economy?
Suppose that unemployment is initially equal to the natural rate and Πt = 8%. The central bank decides that 8% inflation is too high and that, starting in year t, it will maintain the unemployment rate one percentage point above the natural rate of unemployment until the inflation rate has decreased to a new target of 2%.
b. Compute the rate of inflation for years t, t + 1, t + 2, ...
c. For how many years must the central bank keep the unemployment rate above the natural rate of unemployment? Is the implied sacrifice ratio consistent with your answer to a.?
d. Now assume that Πet = 0.5Πt + 0.SΠt-1. For how many years must the central bank keep the unemployment rate above the natural rate of unemployment? What is the sacrifice ratio in this case?
e. Finally assume that Πet = Πt. What is the sacrifice ratio in this case? What is the role of central bank credibility in disinflation process?
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