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

Define debt, Q. Define Debt? Debt:Total amount of money owed by a compa...

Q. Define Debt? Debt:Total amount of money owed by a company, individual or other organization to banks or other lenders is their debt. It represents accumulated total of past

Growth of production, GROWTH OF PRODUCTION: The performance of Indian ...

GROWTH OF PRODUCTION: The performance of Indian agriculture during more than half a century of planned economic development can be broadly characterised by three distinct phas

Project work, PLEASE GIVE ANY ONE TOPIC OF ECONOMIC WITH ANSWERS

PLEASE GIVE ANY ONE TOPIC OF ECONOMIC WITH ANSWERS

What are the differentiated conditions of economic issue, What are the diff...

What are the differentiated conditions of economic issue? While discussing an economic issue, this is very important to differentiate between: (a) Two types of conditions: e

What is meant by non price competition, What is meant by non Price Competit...

What is meant by non Price Competition? In which market structure does it exist?  None price competition is an effort put by the supplier to earn extra profit without enhancing

Micro, a. Suppose the demand for saline solution is perfectly inelastic for...

a. Suppose the demand for saline solution is perfectly inelastic for contact lens wearers. If the government imposes a tax on saline solution, what occurs? Be sure to tell what hap

Preferences toward risk, PREFERENCES TOWARD RISK * Choosing Among Risky...

PREFERENCES TOWARD RISK * Choosing Among Risky Alternatives - Assume - Consumption of a single commodity - The consumer knows all probabilities - Payoffs measured i

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