Answer to Question #218498 in Macroeconomics for Supply

Question

Consider the effects of a permanent decrease in the rate of nominal money growth 

Suppose that the economy can be described by the following three equations:

𝑼𝒕 − 𝑼𝒕−𝟏 = −𝟎. 𝟒(𝒈𝒚𝒕 − 𝟑%)

Okun’s law

𝝅𝒕 − 𝝅𝒕−𝟏 = −𝟎. 𝟒(𝑼𝒕 − 𝟓%)

Phillip’s curve

𝒈𝒚𝒕 = 𝒈𝒎𝒕 − 𝝅𝒕

Aggregate demand

(a) Reduce the three equations to two by substituting gyt from the aggregate demand

equation into Okun’s law. Assume initially that 𝑼𝒕 = 𝑼𝒕−𝟏 = 𝟓%, gmt = 13%, and Πt =

10%, what was the rate of inflation last year?.

(b) Explain why these values are consistent with the statement “Inflation is always and 

everywhere a monetary phenomenon.”

Now suppose that money growth is permanently reduced from 13% to 3%, starting in 

year t.

(c) Compute unemployment and inflation in years t, t + 1, …, t + 10.

(d) Does inflation decline smoothly from 10% to 3%? Why or why not?

Answer 1

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