Question

In: Economics

Suppose that the Phillips curve is given by: ?? = ?? ? + ? − ???...

Suppose that the Phillips curve is given by: ?? = ?? ? + ? − ??? where ?? is the inflation rate, ?? ? is the expected inflation, ?? is the rate of unemployment and, a and b are two positive parameters. Before the COVID-19 crisis, no wage contract was indexed to the inflation. After the crisis a fraction ? > 0 of wage contracts are indexed to inflation.

a. Derive the new equation for the Phillips curve after the crisis.

b. Derive an algebraic expression for the natural rate of unemployment after the crisis. It is believed that the Phillips curve for Canada will be: ?? − ??−1 = 3.2% − 0.4?? 3

c. Plot this curve on a graph with ?? on x-axis and ?? − ??−1 on y-axis.

d. Assume that ? = 0.5, find the numerical values of parameters a and b as implied by the above estimated Phillips curve.

e. What will be the natural rate of unemployment?

Expert Solution

Given : ?? = ??? + ? − ???

a) In case of wage indexation, ? proportion of nominal wages contracts depend on actual inflation and the (1- ? ) proportion, the non-indexed contracts assume inflation to be same as previous period.

Therefore, ??? = ? (??) + (1- ? )(??-1)

Therefore, substituting the value, we get ,

?? = ??? + ? − ??? = ? (??) + (1- ? )(??-1) + ? − ???

?? - ? (??) = (1- ? )(??-1) + ? − ???

(1-?)?? = (1- ? )(??-1) + ? − ???

or ?? = (??-1) + ?/(1-?) − [?/(1-?)]??

The new phillips curve will be steeper as 1/(1 − λ) > 1 and that this factor is increasing in λ, implying that the higher the proportion of indexed contracts the higher the effect of unemployment (represented by (?/(1-?) on inflation.

b) Natural rate of unemployment is when ?? = ??? therefore, ? − ??n= 0,

or ?n = a/b, since, ?n does not depend on indexation, therefore there will be no change in the natural rate of unemployment.

c) ?? − ??−1 = 3.2% − 0.4??

d) ?? = (??-1) + ?/(1-?) − [?/(1-?)]?? is estimated to be ?? − ??−1 = 3.2% − 0.4??

This implies, ?/(1-?) = 3.2, if ?= 0.5, this implies ?/0.5 = 3.2, or a = 1.6

similarly, b/(1-?) = 0.4 , or b/0.5 = 0.4, which implies, b=0.20

e) ?n = a/b = 1.6/0.20 = 8%

Rahul Sunny answered 7 months ago

The Phillips curve, supply shocks, and wage flexibility Suppose that the Phillips curve is given by...

The Phillips curve, supply shocks, and wage flexibility Suppose that the Phillips curve is given by ?? = ?? ? − ?(?? − ?? ) (1) where the natural rate of unemployment, ?? = ?+? ? . [Recall that this Phillips curve was derived under price-setting and wage-setting: ?? = (1 + ?) ?? (2) ?? = ?? ? (1 − ??? + ?) (3) where m is the mark up over marginal cost, which is just the wage rate...

Suppose the economy has the Phillips curve ?? = ??−1 − 0.5(?? − ?? ? ),...

Suppose the economy has the Phillips curve ?? = ??−1 − 0.5(?? − ?? ? ), where the natural rate of unemployment is given by the average of past two years’ unemployment: ?? ? = 0.5(??−1 + ??−2). (i) Why might the natural rate of unemployment depend on recent unemployment (as is assumed in the preceding equation)? [5] (ii) Suppose the Central bank follows a policy to reduce the inflation rate permanently by 1 per centage point. What effect will...

Suppose that there is a fall in oil prices. Use the Phillips curve and/or the AD-AS...

Suppose that there is a fall in oil prices. Use the Phillips curve and/or the AD-AS model to show the short run effects on the economy. State clearly what happens to inflation and unemployment. Why does this pose a challenge for the Fed?

Suppose that the tradeoff between unemployment and inflation is determined by the Phillips curve: ??=???????(???????). In...

Suppose that the tradeoff between unemployment and inflation is determined by the Phillips curve: ??=???????(???????). In addition, suppose that the country involves two political parties, the Left and the Right. Suppose that the Left party always follows a policy of high money growth and the Right party always follows a policy of low money growth. What “political business cycle” pattern of inflation and unemployment would you predict under the following conditions? 1) Every four years, one of the parties takes...

Suppose that the Phillips curve is given by:πt-πt-1=m+z-αut. In addition, you are told the following:

Suppose that the Phillips curve is given by:πt-πt-1=m+z-αut. In addition, you are told the following:If the unemployment rate is 0.07, the inflation rate will riseIf the unemployment rate is 0.10, the inflation rate will fallBased on this information, we can conclude that the natural rate of unemployment isA) lower than 0.07B) equals 0.07C) between 0.07 and 0.10D) higher than 0.10

Draw the modern Phillips Curve and assume v of the Phillips Curve is 1. Show and...

Draw the modern Phillips Curve and assume v of the Phillips Curve is 1. Show and explain the effects of the crisis. By exactly how much should inflation change? Be sure to label everything.

What is the difference between the traditional Phillips curve and the expectations augmented Phillips curve and...

What is the difference between the traditional Phillips curve and the expectations augmented Phillips curve and what are the implications of that difference for stimulatory monetary policy?

Explain the meaning of flat Phillips curve in AD-AS framework. Compared with the steeper Phillips curve,...

Explain the meaning of flat Phillips curve in AD-AS framework. Compared with the steeper Phillips curve, when the Phillips curve is relatively flat, what is the impact of the given aggregate demand shock on the economy? What is the possible impact of the flat Phillips curve on fiscal policy and monetary policy?

INFLATION AND THE PHILLIPS CURVE explain with your own words 1 What is the Phillips curve?...

INFLATION AND THE PHILLIPS CURVE explain with your own words 1 What is the Phillips curve? 2 What is the relationship between inflation and growth?

3. Unemployment, the Phillips Curve and Okun’s Law Suppose the government of Exampleland is considering the...

3. Unemployment, the Phillips Curve and Okun’s Law Suppose the government of Exampleland is considering the introduction of a new trade policy that consists of rescinding existing free-trade agreements and imposing tariffs on imports. a) If the Phillips Curve equation for this economy is ?t = ?t-1 + 0.03 - 0.5ut before the new government policy, which of the following would be more likely to represent the new Phillips Curve after the policy is introduced, and why? (i) ?t =...