Lecture 23 Phillip Curve and ExpectationsPhilip Curve-Samuelson and SolowAdaptive Expectations-Friedman and Phelps-Implications-FlawRational ExpectationsReadings: Today: 17 18Thursday: 19How powerful is the Fed reserve?How powerful is monetary policy?Short-run: Y increase U decrease Inflation increaseLong run: inflation increasePhillips CurvePhillips curve: inverse relationship between inflation and unemployment rate.iuMilton Friedman and Edmund PhelpsAdaptive expectations: Today’s inflation becomes expected inflationtime i I*0 0 01 4 02 4 43 8 44 8 85 4 8When inflation is expected, unemployment is not affectedi=i* then u=u*Fried defined the nature unemployment rateAdaptive Expectations Summaryinflation not always a surpriseAdaptive Expectations FlawProblem: Some predictable errors are still madeIf expectations are adaptive, Dan will have his phone next day but Bill will not.Rational Expectations (RE)The theory that people use all available information when forming expectationsRE does not imply zero forecasting errorsjust that errors are not predictableerrors are randomI and u are not
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