Y5

Consider an expectations-augmented Phillips Curve of the following form:

_t = a [(u_n / u_t) - 1] + b _t^e

where b = 1 and adaptive expectations:

_t^e = _t-1

(a) What are the requirements for a constant rate of inflation over time?

(b) What will be the behavior of inflation when u_t < u_n and what is the economic meaning of this behavior?

(c) What will be the behavior of inflation when u_t > u_n and what is the economic meaning of this behavior?

(d) Why does stagflation pose serious difficulties for policymakers?

(e) What macroeconomic policies, if any, would you propose to deal with stagflation?