Question

In the recent past, Japan and Argentina have had completely different experiences in terms of inflation dynamics. Japan experienced neither sustained inflation nor disinflation, whereas Argentina had very high inflation rates. How would a cut in the target inflation rate affect expectations in the two countries? What does this imply in terms of short-run and long-run Phillips curves?

Answer 1

Japan is one of the developed countries in the world which witnessed low inflation for long time. On the other hand Argentina is one of the the emerging markets in the world which usually witnessed high inflation throughout its development years.

Central Bank in each country e referred above handles the inflation targeting in different ways. In Japan, the existing rates is itself lower. Show the available option for higher cut in the interest rate is less. More cuts will isl take the interest rate to the negative territory. Hence, the expectation will be e less in case of Japan. In case of Argentina, as the inflation was higher, there is more room for cut in the the target inflation rate. Hence the expectation in Argentina will be higher for rate cut.

As per the Philips curve, when inflation rate is higher, the unemployment rate will be lower and as the inflation rate reduces the unemployment rate increases. In our case, for Japan though the inflation is already low, the cut in inflation targeting will have very limited impact in the unemployment. For Argentina, the Philips curve impact can be seen with the inflation targeting cut, the unemployment rates will increase. These impact are in terms of short run. However, as the Philips curve long-run has a steady vertical line unemployment rate despite movement in the inflation rate, the same is come across both these countries.

The short run and long run Philips curve would be as below