Econ Test Number 3

1. Suppose that an economy has the following Phillips curve:

π = π-1 - 0.6 (u - 0.04)

a. What is the natural rate of unemployment?

b. Graph the short-run and long-run relationship between inflation and unemployment. Clearly label the horizontal axis, the vertical axis, the slope of the short-run relationship and the intersection point between the two.

c. How much cyclical unemployment is it necessary to reduce inflation by 5 percentage points? Using Okun’s law, compute the sacrifice ratio.

2. Suppose that the economy is initially at a long-run equilibrium. Then the Fed increases the money supply. Assuming any resulting inflation is unexpected, explain any changes in GDP, unemployment, and inflation that are caused by the monetary expansion. Explain your conclusions using three diagrams: one for the IS-LM model, one for the AD-AS model and one for the Phillips curve.

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3. Use the materials pertaining to the November Federal Open Market Committee meeting available at: http://www.federalreserve.gov/monetarypolicy/fomccalendars.htm

to answer the following questions:

a. What were the most recent actions of the Federal Reserve in terms of monetary policy? What was their goal?

The actions of the Fed were to maintain previous action for a dual mandate of maximum employment and price stability in the longer run. The target range for federal funds rare will remain at 0 to ¼% and will continue to extend the average maturity of securities by purchasing longer term securities and selling an equal amount of shorter term securities.

b. What are the likely actions of the Fed in the near future? Why? Base your answer on some of the economic indicators mentioned in the speech and that are likely to be relevant for future monetary policy.

Based on the composition of the Committee members and their primarily Keynesian views, I believe they will continue the course they have set. The Fed may add the purchases of mortgage-backed securities to...