Inflation-unemployment trade-off under rational expectations, Microeconomics

Assignment Help:

Inflation-Unemployment Trade-off under Rational Expectations:

Robert Lucas (1972) pointed out another implication of the above hypothesis of adaptive expectations. Suppose in a particular period (say period 0) the unemployment rate is lower than the natural rate. Then Φ(0), the actual rate of inflation in period 0 must have been greater than Φe(0), the rate of inflation expected by workers. Now suppose that the rate of growth of nominal demand is such that over time there is a constant rate of inflation Φ(0). Then, from (5.5) it follows that for all t≥0, 

1116_InflationUnemployment Tradeoff under Rational Expectations.png

363_InflationUnemployment Tradeoff under Rational Expectations 1.png

That is, if the expected rate of inflation is less than the actual rate of inflation in mod 0 it will continue to be so in all future time periods even though the difference between the two rates converges to 0 as t->∞.

The implication is that together with a constant rate of inflation, the economy can have a rising rate of unemployment (because the difference between the actual rate of inflation and the rate of inflation expected by workers diminishes over time) but the rate of unemployment can still be lower than the natural rate in every time period (because the actual rate of inflation is always greater than the rate expected by workers). That is over the long run, together with a constant rate of inflation, the economy could still have an average rate of unemployment lower than the natural rate.

Moreover, the above solution also implies that ceteris paribus the greater the value of Φ(0), the greater would be the derivation the actual from the expected rate of inflation in any time period. Therefore, the greater would be the deviation of the actual rate of unemployment from the natural rate in any time period. Hence, the higher the constant rate of inflation in the economy, the lower would be the long-run average rate of unemployment.

This implies that while macroeconomic policy cannot achieve a constant and permanently lower rate of unemployment in an anomy by choosing a constant but permanently higher rate of Won, an inflation-unemployment trade-off still exists. By choosing a constant but permanently higher rate of inflation policy makers can still -achieve a permanently lower rate of unemployment in each period resulting in a lower long-run average rate of unemployment.

 

 

 

 


Related Discussions:- Inflation-unemployment trade-off under rational expectations

Williamson''s model, williomson''s model of managerial discretion

williomson''s model of managerial discretion

Deductive and inductive methods, what are the merits and demerits of deduct...

what are the merits and demerits of deductive inductive methods in economic analysis?

MBA, The market demand for brand X has been estimated as Qx=1500-3Px-0.05I-...

The market demand for brand X has been estimated as Qx=1500-3Px-0.05I-2.5Py+7.5Pz Where Px is the price of brand X, I is per-capita income, Py IS the price of brand Y, and Pz is th

HCA586, how do cooperative and noncooperative games differ

how do cooperative and noncooperative games differ

Organic protons and electrons, Organic biochemistry is really as well as bi...

Organic biochemistry is really as well as biochemistry. This is because the as well as atom is the central source of all existing creature's substances. 8 protons and 8 electro

Demand and supply, draw the demand curve,when there is rise in the price of...

draw the demand curve,when there is rise in the price of a product on the demand of the product

Disadvantages of state trading, Disadvantages of State Trading State tra...

Disadvantages of State Trading State trading has several disadvantages. (i) State trading is often afflicted by the corruption and inefficiency usually associated with the pu

Illustration of externalities, Externalities: Many economic activities have...

Externalities: Many economic activities have collateral effects (at times positive, but more often negative) on other people who aren't directly involved in that activity. Illustra

Arc elasticity, Arc Elasticity is defined below: Arc elasticity measure...

Arc Elasticity is defined below: Arc elasticity measures/calculates the "average" elasticity between two points on the demand curve. The formula is simply given as (change in q

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd