Go to the St. Louis Federal Reserve FRED database, and find data on potential output (GDPPOT), real GDP (GDPC1), a measure of the price level, the personal consumption expenditure price index (PCECTPI), and the University of Michigan inflation expectations measure, (MICH). For the price index series, choose the units as “Percent Change From Year Ago,” and for the inflation expectations measure, choose the frequency as “Quarterly.” Download all of the series onto a spreadsheet.

Create a measure of the output gap, defined as the percentage difference between (actual) real GDP and potential GDP, for each quarter.

a) Estimate a version of the short-run aggregate supply curve using inflation as the dependent (Y) variable and the inflation expectations and output gap measures as independent variables (X variables). Use the transformed data above, from 2000 to the most recent data available, and run a linear regression of these variables. (You can do this in Excel by using the Data Analysis ToolPak.)

b) Are the regression results consistent with a short-run aggregate supply curve model? Are the coefficient values sensible? Interpret the coefficients and briefly explain.

c) How much predictive power does your estimated short-run aggregate supply curve have? Compare your results with those you obtained in Problem 1(b) above (if applicable). Explain the difference in predictive power between the simple Phillips curve estimation and the short-run aggregate supply curve estimation you just created.

d) Based on the most current data available and your regression results, by how much would inflation change if policy makers were to close the output gap?

Data from Problem 1 part b

Using the unemployment and inflation data above, create a fitted (or regression) line of the data on the scatter plot, using the unemployment rate as the independent variable. (Excel has scatter plot layouts that you can use to do this automatically, or you can use Data Analysis with the ToolPak for Excel.) Report the equation for the fitted line.