Consider the following model une,-0.05--0.5m-1 + 1.5m-2 + une,-1 where unet is t
ID: 1121663 • Letter: C
Question
Consider the following model une,-0.05--0.5m-1 + 1.5m-2 + une,-1 where unet is the unemployment rate at time t; t is the inflation rate at time t. (SE are in parenthesis). Question 3.a (6 points): What is the interpretation of the intercept coefficient? . Question 3.b (6 points): what is the interpretation of the coefficient associated with Ti- . Question 3.c (7 points): What is the 2-period cumulative effect of inflation on unemployment? Interpreting this effect as the "long run" effect of inflation on unemployment; what does the regression tell you about the "short run" effect of inflation vs. the "long run" effect ·Question 3.d (6 points) : (a) Suppose that at time T, 0.02 and 7-1-Tr-2 = 0 and uneT-1 0.04 what is your prediction of unemployment at time T? (b) Suppose the actual value of unemployment at time T, was uner 0.05, is your forecast error positive or negative?Explanation / Answer
a. It is basically natural rate of unemployment. That is the unemployment that will stay irrespective of past inflation and unemployment.
b. Past period’s inflation results in decline in current period’s unemployment by 0.5 points
c. Two period cumulative effect is indicated by coefficient of _t-2. It is basically 1.50. That is, it has a positive effect on the unemployment. It indicates that the trade off between inflation and unemployment doesn’t exist in the long run but it certainly does exist in short run.
d.
Ut = 0.05 - 0.02 – 0.5*0 +1.5*0+0.04 = 0.03 – 0 + 0 +0.04 = 0.07
If actual Ut = 0.05, then forecast error = 0.05 – 0.07 = - 0.02.