Macroeconomics Study Set 62

Business

Quiz 17 :

The Trade-Off Between Inflation and Unemployment

Quiz 17 :

The Trade-Off Between Inflation and Unemployment

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Long-term government bonds now pay approximately 3 percent nominal interest. Would you prefer to trade yours in for an indexed bond that paid a 1 percent real rate of interest What if the real interest rate offered were zeroed What if it were negative₁ percent What do your answers to these questions reveal about your personal beliefs about future inflation
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What is a Phillips curve Why did it seem to work so much better in the period from 1954 to 1969 than it did in the₁970s
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Definition of Phillips curve
Phillips curve explains the tradeoff relationship between inflation and unemployment rate. It means if unemployment rate increases, the rate of inflation will decrease and vice-versa.
Justification for Phillips curve performance
The tradeoff between inflation and unemployment happens when there is a demand shock in an economy. Since most of the economies faced demand shock during the perioD₁954 to 1969, the Phillips curve worked much better during this time.
If there is supply shock in an economy, then inflation unemployment tradeoff would not exist. In the₁970s, most of the economies faced the supply shock; hence, the Phillips curve did not seem to work better in this period.

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When inflation and unemployment fell together in the₁990s, some observers claimed that policy makers no longer faced a trade-off between inflation and unemployment. Were they correct
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Rejecting inflation unemployment tradeoff is incorrect
When inflation and unemployment fell together in the₁990s, some observers claimed that policy makers no longer faced a trade-off between inflation and unemployment.
This observation is incorrect because inflation and unemployment will fall/rise together when there is a supply shock in an economy. On the other hand, tradeoff between inflation and unemployment occurs when there is a demand shock in an economy.
Hence, rejecting inflation unemployment tradeoff based on supply shock analysis is incorrect.

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Explain why expectations of inflation affect the wages that result from labor-management bargaining.
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Why is it said that decisions on fiscal and monetary policy are, at least in part, political decisions that cannot be made on "objective" economic criteria
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The year 2014 closed with the unemployment rate just below 6 percent, real GDP growing at roughly 2.5 percent, inflation below 2 percent, and the federal budget showing a deficit under 3 percent of GDP. a. Give one or more arguments for engaging in expansionary monetary or fiscal policies under these circumstances. b. Give one or more arguments for engaging in contractionary monetary or fiscal policies under these circumstances. c. Which arguments do you find more persuasive (This is a question you might want to discuss in class.)
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Show that if the economy's aggregate supply curve is vertical, fluctuations in the growth of aggregate demand produce only fluctuations in inflation with no effect on output.
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It is often said that the Federal Reserve Board typically cares more about inflation and less about unemployment than the administration. If this is true, why might presidents often worry about what the Fed might do to interest rates
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"There is no sense in trying to shorten recessions through fiscal and monetary policy because the effects of these policies on the unemployment rate are sure to be temporary." Comment on both the truth of this statement and its relevance for policy formulation.
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What is meant by "rational" expectations Why does the hypothesis of rational expectations have such stunning implications for economic policy Would believers in rational expectations want to shorten a recession by expanding aggregate demand Would they want to fight inflation by reducing aggregate demand Relate this analysis to your answer to Test Yourself Question 1. Reference Test Yourself Question 1. Show that if the economy's aggregate supply curve is vertical, fluctuations in the growth of aggregate demand produce only fluctuations in inflation with no effect on output.
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