Reading...
Play button
Play button
Use LEFT and RIGHT arrow keys to navigate between flashcards;
Use UP and DOWN arrow keys to flip the card;
H to show hint;
A reads text to speech;
9 Cards in this Set
- Front
- Back
|
How do recessions cure inflation?
|
Take the Phillips curve:
pi = pi(e) + a - bU U* = a/b pi = pi(e) + bU* - bU pi = pi(e) + b(U*-U) pi = pi(e) - b(U-U*) So allow unemployment U to be high so that inflation pi is low. |
|
|
What is the rule of thumb for reducing inflation?
|
Each 1% of extra unemployment for a year reduces inflation by 1/2 point, that is, b = 0.5.
|
|
|
Why is the expected inflation more than the actual inflation?
|
pi(e) = last year's pi. This is because people don't really expect the inflation to change very much from the previous year.
|
|
|
Why is reducing inflation of the 1980s costly?
|
Inflation decreased but unemployment rose by twice as much due to the b=1/2.
|
|
|
What are the two theories regarding inflation and unemployment?
|
1. Inertia theory.
2. Rational Expectations theory. |
|
|
What is the rational expectations theory?
|
pi = pi(e) + random number
pi - pi(e) = random number b(U-U*) = random number unlike in inertia theory where U can be manipulated. |
|
|
Why is the rational expectations theory different from the inertia theory?
|
According to rational expectations theory, short run PC is vertical, vibrates randomly. There is no social cost involved in reducing inflation. It does not involve increasing unemployment.
|
|
|
In the absence of inertia in expectations, what else makes it difficult to cut inflation by a large amount?
|
Labor contracts make it impossible to cut inflation by a large amount. Labor contracts override new policies instituted and rules are built into system for specified length of time.
|
|
|
What else would affect people's rational expecations?
|
The government must make people believe that they will combat inflation and really go ahead to do it.
|
