Workbook For Chapter 8 Of Blanchard Macroeconomics. Problem 3 Mutations of the Phillips Curve. The Phillips Curve is an empirical relation between inflation and unemployment. In the 1960s, this factual relationship seemed clear and quite simple: higher inflation, lower unemployment. This has changed since the 1970s, precisely because policy makers took advantage of the simpler version of the Phillips curve. Now, the facts seem to suggest that the relation between inflation and unemployment goes through the changes in those two variables. In this exercise we explore why. Suppose that the Phillips curve is given by tettu21.0 −+=ππ Where 1−=tetθππ, and θ = 0 initially. a. What is the natural rate of unemployment? (Refer to equations 8.4 and 8.8). ___________________________________________________________________ Suppose that the rate of unemployment is initially equal to the natural rate. For years, the authorities have had no policy regarding unemployment, letting it fluctuate on its own. b. Fill in this table. Year u ttu21.0−=π t – 4 0.06 t – 3 0.02 t – 2 0.04 t – 1 0.08c. On average, π is = ______________. Since the authorities don’t do anything systematic to the unemployment rate, and it just fluctuates randomly, for any random year, you might expect π to be _____________________________ = π e. In year t, the authorities decide to bring the unemployment rate down to 3% and hold it there forever. d. Fill in this table. Year u ttu21.0−=π t 0.03 t +1 0.03 t +2 0.03 t+5 0.03 e. Do you believe the answer in (b)? If you were a citizen in this country, and you saw the rates of inflation you found above, how would you adjust your expectations of inflation? π e= _________________________________________. Explain why ________________________________________________________ ___________________________________________________________________. Now suppose that in year t + 5, θ increases from 0 to 1, so that 1−=tetππ. Suppose that the government is still determined to keep u at 3% forever. f. Why might θ increase in this way? In other words, why would economic agents choose to base their expectations on last year’s inflation, rather than on anything else? ____________________________________________________ ___________________________________________________________________. (This is an important point of model-writing: there are probably a thousand other ways to specify the process of expectations formation. This one is convenient. Explain why it makes sense.) g. Fill in this table. Year u tttu21.01−+=−ππ t+6 0.03 t +7 0.03 t +8 0.03 Find the t+5 value on the previous table.h. Do you believe the answer in (g)? Why or why not? ______________________ ___________________________________________________________________. Problem 4 Hint for part (a). It will help to define “markup over wages” first and to give several reasons for why it may arise. Hint for part (b). Start by looking at equation 8.8. Then explain, in words, the relation between the cost of production, the structure of the productive sector, the level of production, and the level of unemployment when cyclical unemployment is zero. Problem 7 Hints. The question asks you to compare year-by-year figures of the change in inflation and unemployment. Since these data are monthly, you need to “convert” them into annual figures. You do that by 1. taking averages of unemployment for the 12 months in each year (because unemployment is a stock: the “pool” of the unemployed) and 2. by calculating the percentage rate of change of the CPI from December to December (you could also take a yearly average). 11−−−=ttttCPICPICPIπ a. Make sure you get CPI data from 1968 to 2004. Then calculate the change in inflation from year to year. You do this by asking Excel to calculate this formula 1−−ttππ (It sounds obvious once it is explained, but it is not hard to get confused if you’re not paying attention). Since the problem asks you for the 1970 – 2004 period (we don’t have data for the whole of 2005 yet), you should end up with 25 observations for each variable, u and 1−−ttππ.• Copy and paste both series next to each other in an Excel worksheet, with u on the right and 1−−ttππ on the left. (Obviously, 1970 u should be right next to 1970 1−−ttππ). • Select all the data for both series. • Then click on Insert|Chart. On the first screen, select XY (Scatter). • Click Next twice. • In Step 3, on the Titles tab, type Unemployment Rate under Value (X) Axis and Change in Inflation under Value (Y) Axis. • Click Next. • In Step 4, select As object in. • Click Finish. • Select the graph, copy it, and paste it into your homework. The rest should be pretty straightforward. Dr. Gabriel Martinez Academic 2056 [email protected] (239)