1.

The Phillips Curve is

e
π=2.5−0.5 u+ π

where π is the inflation rate and u is the unemployment rate. π e is the expected inflation rate. What
is the natural rate of unemployment?

The Government has a loss function V =C−u 2−π 2. What is the inflation rate in the Nash
equilibrium of the game between the Government and the private sector. (Hint. What shape are the
Government’s indifference curves? The tangent to a circle meets the radius at a right angle)

Or solve the problem by algebra rather than geometry. Substitute into the Government’s loss
function the inflation rate in terms of expected inflation and unemployment. Then minimise the
Government’s loss function to find unemployment in terms of expected inflation . Substitute into
this the long-run unemployment rate and calculate expected inflation.
2 2
V =C−u −π
e
u=2×(2.5+ π −π )
2
V =C−4 × ( 2.5+ π −π ) −π
e 2

∂V
=8 × ( 2.5+ π −π ) −2 π =0
e
∂π
e
10 π=20+ 8 π

If π e =π then π = 10 and u=5

e
Suppose π =π t−1 . Then π t =2+ 0.8 π t−1. Thisconverges ¿ π = 10
2. Please watch the address by Ben Bernanke at https://www.nber.org/lecture/2022-inflation-
expectations-determinants-and-consequence-keynote-ben-bernanke-inflation-expectations and
read the article by Rudd (2021)

I would like to discuss the following issues in the class.

1. What lessons do you draw from the inflationary burst of 2021-2023

2. Where do Rudd’s arguments leave us?
3. In the light of recent movements in inflation, do you think central banks, and the Bank of
England in particular, have a credibility issue?