Question

1. Disinflation. Suppose a country’s current inflation rate is 18%, Central bank wants to reduce the inflation rate to 3% in five years, in other words, a reduction of 3 percentage points per year. Given Okun’s law u_t-u_t-1=-0.4(g_yt-3%), Phillips Curve $\pi$_t-$\pi$_t-1=-(u_t-6%) and nominal money growth g_y=g_m-$\pi$, complete the following table to derive the desired path of disinflation.

	before	Years of disinflation					After
year	0	1	2	3	4	5	6	7	8
Inflation %	18	15	12	9	6	3	3	3	3
Umemployment rate %	6
Output growth %	3
Nominal money growth %	21

Answer 1

	before	Years of disinflation				After
year	0	1	2	3	4	5	6	7	8
Inflation %	18	15	12	9	6	3	3	3	3
Unemployment rate %	6	9	9	9	9	9	6	6	6
Output growth %	3	-4.5	3	3	3	3	10.5	3	3
Nominal money growth %	21	10.5	15	12	9	6	13.5	6	6

The calculation is as follows:

• Step 1: $u_t=\pi _{t-1}-\pi_t+6$
• Step 2: $g_y_t=\frac {u_{t-1}-u_t}{0.4}+3$
• Step 3: $g_m=g_y_t+\pi_t$