please explain how to do this. Suppose that the Phillips curve is given by pi t

Question

please explain how to do this.

Suppose that the Phillips curve is given by pi t = + 0.1 - 2ut Assume = theta pi t-1 and suppose that theta is initially equal to 0. Suppose that the rate of unemployment is initially equal to the natural rate. In year t, the authorities decide to bring the unemployment rate down to 3% and hold it there forever. What are the rate of inflation in years t, t+1, t+2 and t+4? According to how people are likely to form expectations of inflation, the answer from a) is not quite logical. Why not?

Explanation / Answer

piet = 0.1 - 2*0.03 = 0.04

piet+1e = 0

piet+1 = 0.1 - 2*0.03 = 0.04

piet+2e = 0

piet+2 = 0.1 - 2*0.03 = 0.04

piet+4 = 0.1 - 2*0.03 = 0.04

It is not quite logical as people simply expect the inflation to be same every year, even though the unemployment rate is reduced. This is not in accordance with the Philips curve.

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