ECON 17.3

Workers generally form their expectations of future inflation based on the current conditions in the economy. Which one of the following does not reflect how they form their​ expectations?

During periods of high​ inflation, people do not take any particular action until the Fed has controlled the inflation rate.

An article in the Economist magazine contains the​ following: ​"Robert Lucas . . . showed how incorporating expectations into macroeconomic models muddled the framework economists prior to the​ 'rational expectations​ revolution' thought they saw so​ clearly." ​Source: "How to Know What Causes​ What," Economist​, October​ 10,2011. What economic framework did economists change as the result of​ Lucas's arguments?

Economists changed the theory of​ "adaptive expectations" where people assume that future rates of inflation will follow the past rates of inflation.

In a real business cycle​ model, which of the following best explains an increase in real GDP above the​ full-employment level?

a positive technology shock

If Lucas and Sargent were​ right,

an expansionary monetary policy would not work if people had rational​ expectations, since they will use all available information including knowledge of the effects of the​ Fed's monetary policy.

Why are these economists skeptical about the​ Fed's ability to successfully stabilize the​ economy? These economists doubt the​ Fed's ability to stabilize the economy because they believe that

changes in real factors like technology​ shocks, and not monetary​ policy, explain movements in real GDP.

​Workers, firms,​ banks, and investors in financial markets care about the future rate of inflation because

if actual inflation turns out to be different from the expected​ inflation, real​ wages, profits, and interest will be different from their expected values.

b. What does the columnist mean by​ "stabilize the​ economy"? By​ "stabilize the​ economy," the columnist means

implementing policies that will result in real GDP being equal to potential GDP and reducing the severity of the business cycle.

The effect is

more likely if inflation is unanticipated because workers would not seek higher nominal wages.

a. Which school of thought do these three economists belong​ to? ​Lucas, Prescott, and Sargent all belong to the​ __________ school of thought.

new classical

Do all economists agree with​ Lucas's main conclusions about the effectiveness of monetary​ policy? Briefly explain. Many economists have remained skeptical of all the​ following, except

that there is a​ short-run trade-off between unemployment and inflation.

If workers and firms have rational expectations and wages and prices adjust​ quickly, then if the Fed announces a credible expansionary monetary​ policy,

the inflation rate will​ increase, but the unemployment rate will be unchanged.

Suppose that the inflation rate is increasing each year for a number of​ years, then

the rational expectations hypothesis is likely to give more accurate forecasts because if workers or firms have rational​ expectations, then they will use all the available information to forecast future inflation.

Robert Lucas and Thomas Sargent argued that

there might not be a​ trade-off between unemployment and inflation in the short​ run, and the​ short-run Phillips curve would be vertical.

If workers and firms have rational​ expectations, they will

use all available information when forming their expectations of future​ inflation; thus, the actual inflation rate will be equal to the expected inflation rate.

A columnist on forbes.com observes that​ "Robert Lucas argues that economic policy which depended on tricking people would not long​ work." ​Source: Bill​ Conerly, "Economic​ Forecast: Theories Behind The​ Numbers," forbes.com​, September​ 1, 2017. Do you agree with this characterization of​ Lucas's position? Briefly explain.

​Yes, if people have rational​ expectations, they will incorporate all available​ information, including the effects of Federal Reserve​ policy, into their​ expectations, and the​ Fed's attempt to run an expansionary policy will be ineffective.

If workers ignore inflation in forming their expectations of the real wage​ rate, what is the effect of an expansionary monetary​ policy?

A move up along the​ short-run Phillips curve.

What effect does expansionary monetary policy have on equilibrium if consumers have rational expectationsLOADING...​?

A movement from point A to point C.

An article in the Economist observes that​ "a sudden unanticipated spurt of inflation could lead to rapid economic​ growth." ​Source:​ "How We Got​ Here," Economist​, January​ 21, 2013. This statement implies that there is a --- relationship between inflation and economic growth.

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