3a 10 sept 2020

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Macroeconomics of Finance, 10 September 2020 (Prof. A. Florio) Exercise 1 “In recent years, however, inflation has fallen pers istently short of the central bank’s target in many countries. In the immediate aftermath of the global financial crisis, such low inflation was no puzzle. Unemployment rose sharply, reaching 10% in America in October 2009.” (The Economist, 22nd August 2020) a) Why, in that occasion, “low inflation was no puzzle”? Comment carefully explaining the macroeconomic relationship behind such a statement. b) In the absence of any puzzle, the relationship is supposed to have a given slope “but central banks’ policies tilt the other way”. Explain this sentence (think, for example, to the reaction by the central bank to a rise in inflation). The above article goes on describing the puzzle: “But after the recovery inflation continued to remain muted even as unemployment in America, the euro are and japan fell unusually far. That has forced economists to rethink the relationship.” And it adds: “inflation expectations can (…) explain part of the puzzle. They have been low for decades.” c) How would you expect the relationship to change if there is a reduction in inflation expectations? Provide a graphical analysis comparing the two curves and explain your answer. d) What happens to the relationship if inflation becomes less sensitive to unemployment? Provide a graphical analysis comparing the two curves and explain some reasons why this could happen. At the end of August, at the Jackson Hole’s symposium, Mr. Powell claimed: “ As the unemployment rate moved lower and inflation remained muted, estimates of u-star were revised down.” e) Explain this statement. (What is u-star? Why was it revised down?) On that occasion Powell announced a revision of the Fed’s…