Natural Rate Hypothesis

Question 1

Two parts of the Natural Rate Hypothesis

Answer 1

(1) There is a natural rate of unemployment (output)
(2) Monetary Policy cannot sustain unemployment (output) below the natural rate without leading to higher and higher inflation (accelerating inflation)

Question 2

Major goals of economic policy

Answer 2

• high employment
• stable prices
• rapid growth

Question 3

What monetary policy cannot do?

Answer 3

• Peg (fix) nominal interest rates
• Target level of employment ( or unemployment)

Question 4

What can monetary policy do?

Answer 4

• Facilitate economic growth
• Contribute to offsetting major economic disturbances
• prevent money itself from being a major source of economic disturbances

Question 5

What can monetary policy control?

Answer 5

• Exchange Rate
• Price level
• quantity of money

Question 6

Potential Output

Answer 6

The level of output is the level of production firms would produce if all prices were flexible.

the level of output the economy could produce if all inputs were being used to maximum intensity without generating broad inflationary pressures.

Question 7

Output gap

Answer 7

The difference between GDP (in logs) and potential output (in logs)

u-u^n>0 y-ybar>0 spare capacity
u-u^n<0 y-ybar<0 excess capacity

Question 8

Summary of Natural Rate Hypothesis

Answer 8

• there is always a temporary tradeoff between inflation and unemployment; there is no permanent tradeoff

Question 9

supply Function

Answer 9

y=m-p
y= ybar+b(p-E[p])

E[p]=mbar-ybar

Question 10

Supply Function

Answer 10

m=mbar +e