The Phillips curve describing an economy takes the form u = uⁿ - α(π - Eπ). The central bank directly sets the inflation rate to minimize the following loss function, L (u, π) = u + γπ². The symbol u denotes the unemployment rates, uⁿ is the natural rate of unemployment, π is the inflation rate, Eπ is the expected inflation rate, and α and γ are behavioural response parameters of the economy. Private agents form their expectations rationally before the central bank sets the inflation rate. Compared to making monetary policy with discretion, the optimal inflation rate will be _____ under a fixed rule and the unemployment rate will be _____. A)higher; lower B)higher; the same C)lower; lower D)lower; the same

Question

Quizplus · Accepted Answer

Under a fixed rule, the central bank commits to a policy that avoids the inflation bias present in discretionary policy, leading to lower inflation without affecting the natural rate of unemployment.

The Phillips Curve Describing an Economy Takes the Form U