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3. Monetary Policy Using the Phillips Curve. 20 points In recent years, people have had fairly constant expectations of inflation around 2 percent. We will
3. Monetary Policy Using the Phillips Curve. 20 points In recent years, people have had fairly constant expectations of inflation around 2 percent. We will explore how people's expectations affect the Fed's policy behavior. Suppose the Phillips Curve is given by 1= Thy - B( u, -1) + V and short-run fluctuations in output and employment are captured by this version of Okun's Law JAY - -2(u, - ) Assume that v -O. B -0.5, and u 4. (d) Notice from (b) that when output falls, we see inflation move in the same direction in the short run. Suppose that people are somewhat sophisticated and incorporate this into their formation of inflation expectations. Assume 14 - (1 - 0)2+ 0%AY where 0
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