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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