Question

Suppose expected inflation rate ($\pi^e_t$) of an individual is formed as:
$\pi^{e}_t = (1 − \theta) \overline{\pi} + \theta \pi_{𝑡−1}$
where, $\overline{\pi}$ is constant inflation rate, $\pi_{t−1}$ is previous year’s inflation rate, and $0 \leq \theta \leq 1$ is weight assigned to inflation rate at different points in time.
Then, which of the following is NOT CORRECT?

• A. If $\theta = 0$, then the individual assumes a constant inflation rate
• B. If $\theta \approx 1$ and $\overline{\pi} < \pi_{𝑡−1}$, then the individual expects this year’s inflation rate to be similar to last year
• C. The original Phillips curve is derived under the assumption of $\theta \approx 1$
• D. A modified Phillips curve is derived under the assumption of $\theta = 1$

Answer 1

Answer: (C)

The original Phillips curve is derived under the assumption of $\theta \approx 1$

Answer 2

The correct answer is (C):The original Phillips curve is derived under the assumption of $\theta \approx 1$