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 SOLUTIONS TO CHAPTER 7

Problem 7.1
When t is even, the price level is given by
(1) pt = fpt1 + (1 - f)pt2,
where pt1 denotes the price set for t by the fraction f of firms who set their prices in the odd period t – 1,
and pt2 denotes the price set for t by the fraction (1 – f) of firms who set their prices in the even period
t – 2. Now, pt1 equals the expectation as of period t – 1 of pit* and thus
(2) pt1 = Et-1 pit* = Et-1 [mt + (1 - )pt ].
Substituting equation (1) into equation (2) and using the fact that pt2 is already known when p1t is set and
is thus not uncertain, yields
(3) pt1 = Et-1 mt + (1 - ) [fpt1 + (1 - f)pt2 ].
Some simple algebra allows us to solve for pt1 :
 (1   )(1  f ) 2
(4) p 1t  E t 1 m t  pt .
1  (1  ) f 1  (1   ) f

Now, pt2 equals the expectation as of period t - 2 of pit* and thus

(5) pt2 = Et-2 pit* = Et-2 [mt + (1 - )pt ].
Substituting equation (1) into equation (5) yields
(6) pt2 = Et-2 mt + (1 - ) [fEt-2 pt1 + (1 - f)pt2 ].
We need to find Et-2 pt1 . Since the left- and right-hand sides of equation (4) are equal and since
expectations are rational, the expectation as of period t - 2 of these two expressions must be equal. That
is, we have
 (1  )(1  f ) 2
(7) E t  2 p1t  E t 2 m t  pt ,
1  (1   ) f 1  (1   ) f
where we have used the law of iterated projections so that Et-2 Et-1 mt = Et-2 mt . Substituting equation (7)
into equation (6) yields
 f (1  )(1  f ) f 2 
(8) p 2t  E t  2 m t  (1   )  E t 2 m t  p t  (1  f ) p 2t  .
 1  (1   ) f 1  (1   ) f 
Collecting terms gives us
    (1   ) f  (1   ) f   (1   )(1  f ) f  (1  f )  (1   )(1  f ) f  2
(9) p 2t    E t  2 m t  (1  )   pt ,
 1  (1   ) f   1  (1   ) f 
which simplifies to
 (1   )(1  f ) 2
(10) p 2t  E t 2 m t  pt .
1  (1   ) f 1  (1   ) f
Collecting the terms in pt2 gives us
1  (1  )f  (1  )(1  f )  2 
(11)  p t  E t 2 m t ,
 1  (1  )f  1  (1  )f
or simply
 
(12) p 2t  E t 2 m t .
1  (1  ) f 1  (1   ) f
And thus the price set in period t - 2 is given by
(13) pt2 = Et-2 mt .

Now to solve for the price set for t by those setting price in t - 1, substitute equation (13) into equation
(4):

© 2012 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
7-2 Solutions to Chapter 7

 (1   )(1  f )
(14) p 1t  E t 1 m t  E t 2 m t .
1  (1  ) f 1  (1   ) f
Adding and subtracting Et-2 mt to the right-hand side of equation (14) yields
  (1   )(1  f )  1  (1   ) f 
(15) p 1t  E t  2 m t  E t 1 m t    E t 2 m t .
1  (1   ) f  1  (1  ) f 
Since (1 - )(1 - f) - 1 + (1 - )f = -(1 - )f + (1 - ) - 1 + (1 - )f = -, equation (15) can be rewritten as

(16) p 1t  E t  2 m t 
1  (1  ) f
 E t1m t  E t2 m t  .

To get an expression for the aggregate price level, substitute the formulas for pt1 and pt2, equations (16)
and (13), into equation (1):
  
(17) p t  f  E t  2 m t 
1  (1   ) f
 E t 1 m t  E t  2 m t    (1  f ) E t  2 m t .


Simplifying yields
f
(18) p t  E t  2 m t 
1  (1  ) f
 E t1m t  E t2 m t  .

To solve for output in period t, substitute equation (18) into the expression for aggregate demand,
yt = mt - pt :
f
(19) y t  m t  E t  2 m t 
1  (1  ) f
 E t1m t  E t2 m t  .
Collecting the terms in Et-2 mt as well as adding and subtracting Et-1 mt to the right-hand side of equation
(19) gives us
  f  1  (1  ) f   1  (1   ) f   f 
(20) y t  m t  E t 1 m t    E t 2 m t    E t 1 m t .
 1  (1   ) f   1  (1   ) f 
Since f - 1 + (1 - )f = -(1 - f) and 1 - (1 - )f - f = (1 - f), equation (20) can be rewritten as
(1  f )
(21) y t 
1  (1  ) f
 E t1m t  E t2 m t    m t  E t1m t  .
Equations (18) and (21) give equilibrium price and output for an even period.

The analysis for the case of t odd is identical to the preceding analysis, except that the roles of f and
(1 – f ) are reversed. Thus derivations analogous to those used to obtain (18) and (21) yield
 (1  f )
(22) p t  E t  2 m t 
1  (1   )(1  f )
 E t 1m t  E t 2 m t  ,
and
f
(23) y t 
1  (1  )(1  f )
 E t 1m t  E t2 m t    m t  E t 1m t  .
Equations (22) and (23) give equilibrium price and output for an odd period.

Problem 7.2
We will deal first with firms that set price in odd periods. Suppose that period t is an even period. Then
pit is the price set for an even period by a firm that sets prices in odd periods and pit+1 is the price set for an
odd period by a firm that sets prices in odd periods. From equation (16) in the solution to Problem 7.1, pit
is given by

(1) p it  E t 2 m t 
1  (1  ) f
 E t1m t  E t2 m t  .

© 2012 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
 Solutions to Chapter 7 7-3

With the assumption that m is a random walk, we have Et-2 mt = mt-2 and Et-1 mt = mt-1 . Thus

(2) p it  m t 2 
1  (1   ) f
 m t1  m t2  .
As usual, the optimal price for period t is given by
(3) pit* = mt + (1 - )pt .
From equation (18) in the solution to Problem 7.1, the aggregate price level in an even period is
f
(4) p t  E t  2 m t 
1  (1  ) f
 E t1m t  E t2 m t  .
Again, since m follows a random walk, this is equivalent to
f
(5) p t  m t 2 
1  (1  ) f
 m t1  m t2  .
Substituting equation (5) into equation (3) yields the optimal price in period t:
(1   ) f
(6) p it *   m t  (1   ) m t 2 
1  (1   ) f
 m t1  m t2  .
Thus, the amount of profit a firm expects to lose in period t is proportional to E t [(p it  p *it ) 2 ] or
  (1  )f  
2

E t  m t 2  (m t 1  m t 2 )  m t  (1  )m t  2  m t 1  m t 2  
 1  (1  )f 1  (1  )f  

Collecting terms yields
 1  (1  )f   
2
2 
(7) E t [(p it  p it *) ]  E t   m t  m t 1  m t 2   m t 2   .
 1  (1  )f  

Simplifying gives us
(8) Et [(pit - pit*)2 ]= Et [(-mt + mt-1 - mt-2 + mt-2 )2],
or
(9) Et [(pit - pit*)2 ]= 2 Et [(mt-1 - mt )2].

Now, the price set for an odd period by a firm that sets prices in odd periods is given by
(9) pit+1 = Et-1 mt+1 .
Since m follows a random walk, Et-1 mt+1 = mt-1 and thus
(10) pit+1 = mt-1 .
The optimal price for period t + 1 is given by
(11) pit+1* = mt+1 + (1 - )pt+1 .
From equation (22) in the solution to Problem 7.1, the aggregate price level in an odd period is
 (1  f )
(12) p t 1  E t 1 m t 1 
1  (1   )(1  f )
 E t m t 1  E t 1m t 1  .
Since Et-1 mt+1 = mt-1 and Et mt+1 = mt , we have
 (1  f )
(13) p t 1  m t 1 
1  (1  )(1  f )
 m t  m t 1  .
Substituting equation (13) into equation (11) yields the optimal price in period t + 1:
(1  ) (1  f )
(14) p it 1 *   m t 1  (1   ) m t 1 
1  (1  )(1  f )
 m t  m t 1  .
Thus the amount of profit a firm expects to lose in period t +1 is proportional to
 (1  )(1  f )  
2
2
(15) E t [(p it 1  p it 1 *) ]  E t  m t 1  m t 1  (1  ) m t 1  m t  m t 1   .
 1  (1  )(1  f )  


© 2012 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
7-4 Solutions to Chapter 7

Collecting terms gives us

 (1  )(1  f )  
2
2
(16) E t [(p it 1  p it 1 *) ]  E t  (m t 1  m t 1 )  m t 1  m t   .
 1  (1  )(1  f )  

Expanding the right-hand side of equation (16) yields
2(1  )(1  f )
E t [(p it 1  p it 1 *) 2 ]   2 E t [(m t 1  m t 1 ) 2 ]  E t [(m t 1  m t 1 )(m t 1  m t )] 
1  (1  )(1  f )
(17) 2
 (1  )(1  f )  2
  E t [(m t 1  m t ) ].
1  (1  )(1  f ) 
Since m follows a random walk, we have Et [(mt-1 - mt+1 )(mt-1 - mt )] = Et [mt-1 - mt+1 ]Et [mt-1 - mt ] =
(mt-1 - mt )(mt-1 - mt-1 ) = 0. Thus, the second term on the right-hand side of equation (17) is equal to 0.
Using this fact, we can add equations (8) and (17). Thus, the total amount of profit a firm setting prices in
odd periods expects to lose is proportional to Et [(pit - pit*)2 ]+ Et [(pit+1 - pit+1*)2 ] or
(18) Exp. Lossodd =
2
 (1  )(1  f ) 
 2 E t [(m t 1  m t ) 2 ]   2 E t [(m t 1  m t 1 ) 2 ]    E t [m t 1  m t 2 ] .
1  (1  )(1  f ) 

Now we will deal with firms that set price in even periods. When period t is an odd period, analysis
parallel to that used to derive (8) shows that the amount of profit a firm expects to lose in period t + 1 is
proportional to
(19) Et (pit - pit*)2 = 2 Et (mt-1 - mt )2.

Analysis parallel to that used to derive (17) shows that the amount of profit a firm expects to lose in
period t + 1 is proportional to
2(1  )f
E t [(p it 1  p it 1 *) 2 ]   2 E t [(m t 1  m t 1 ) 2 ]  E t [(m t 1  m t 1 )( m t 1  m t )] 
1  (1  )f
(20) 2
 (1  )f  2
  E t [(m t 1  m t ) ].
 1  (1   )f 
Note that this is identical to (17) except that the roles of f and (1 – f ) are reversed. Proceeding as above,
since m follows a random walk, we have Et [(mt-1 - mt+1 )(mt-1 - mt )] = Et [mt-1 - mt+1 ]Et [mt-1 - mt ] =
(mt-1 - mt )(mt-1 - mt-1 ) = 0. Thus, the second term on the right-hand side of equation (20) is equal to 0.
Using this fact, we can add equations (19) and (20). Thus, the total amount of profit a firm setting prices
in even periods expects to lose is proportional to Et [(pit - pit*)2]+ Et [(pit+1 - pit+1*)2] or
2
 (1  )f 
2 2 2
(21) Exp. Losseven =  E t [(m t 1  m t ) ]   E t [(m t 1  m t 1 ) ]   2
 E t [m t 1  m t 2 ] .
1  (1  )f 

We need to compare the right-hand sides of equations (18) and (21). Recall that f is the fraction of firms
that set prices in odd periods. Note that with f < ½ –more firms setting prices in even periods than in odd
periods—we have (1 - f) > f. Using this and the fact that  < 1, we can say that
 (1  ) (1  f )  2  (1   ) f  2
(22)     ,
 1  (1   )(1  f )   1  (1   ) f 
since (1 - )(1 - f) > (1 - )f and 1 - (1 - )(1 - f) < 1 - (1 - )f.

© 2012 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
 Solutions to Chapter 7 7-5

Thus, the right-hand side of equation (18) is greater than the right-hand side of equation (21). This means
that the profit a firm expects to lose if it sets prices in odd periods exceeds the profit a firm expects to lose
if it sets prices in even periods. Thus it is not optimal to set prices in odd periods and firms would like to
switch to setting prices in even periods. This means that with  < 1, if we start with f < 1/2, we would
expect to see f go to zero; no firms will set price in odd periods.

By reasoning analogous to that above, we could show that if f > 1/2, the inequality in (22) is reversed.
Firms setting prices in even periods expect to lose more than firms setting prices in odd periods. Thus it
is not optimal to set price in even periods and firms would like to switch to setting prices in odd periods.
This means that with  < 1, if we start with f > 1/2, we would expect to see f go to one; all firms will set
price in odd periods.

Thus if  < 1, staggered price setting with f = 1/2 is not a stable equilibrium. If the economy starts with
anything other than f = 1/2, staggered price setting will not prevail. The economy will move to a situation
in which all firms set price in the same period.

Problem 7.3
(a) The representative individual will set her price equal to the average of the optimal price for t and the
expected optimal price for t + 1. Thus
(1) xt = (pit* + Et pit+1*)/2.
Since pit* = mt + (1 - )pt and this holds for all periods, we have
(2) xt = [(mt + (1 - )pt ) + (Et mt+1 + (1 - )Et pt+1 )]/2.

(b) With synchronization, pt = xt and pt+1 = xt and thus

(3) xt = [(mt + (1 - )xt ) + (Et mt+1 + (1 - )xt ]/2.
Simplifying yields
(4) xt = [2(1 - )xt + (mt + Et mt+1 )]/2.
Collecting the terms in xt yields
(5) [1 - (1 - )]xt = (mt + Et mt+1 )/2,
and thus
(6) xt = (mt + Et mt+1 )/2.
Firms set their price equal to the average of this period's value of m and the expected value of next
period's value of m.

(c) Substitute pt = xt = (mt + Et mt+1 )/2 into the aggregate demand equation to obtain
(7) yt = mt - (mt + Et mt+1 )/2.
Simplifying gives us
(8) yt = (mt - Et mt+1 )/2.
Assuming that m follows a random walk so that Et mt+1 = mt , we have
(9) yt = (mt - mt )/2,
or simply
(10) yt = 0.

Now, substituting pt+1 = xt = (mt + Et mt+1 )/2 into the aggregate demand equation for period t + 1 gives us
(11) yt+1 = mt+1 - [(mt + Et mt+1 )/2].
Assuming that m follows a random walk so that Et mt+1 = mt , we have
(12) yt+1 = mt+1 - (mt + mt )/2,
or simply
(13) yt+1 = mt+1 - mt .

© 2012 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
7-6 Solutions to Chapter 7

The central result of the Taylor model does not continue to hold. Nominal disturbances that occur in
periods when firms are not setting prices feed through one-for-one into output; see equation (13).
However, once firms set prices again, output returns to its normal value of 0; see equation (10).

Intuitively, we have removed the mechanism by which the Taylor model generates long-lasting effects of
nominal disturbances. In the Taylor model, once firms get to adjust price, they do not adjust fully to a
nominal disturbance because they know that not all firms are adjusting at that time. Thus fully adjusting
will change their relative price, which they are reluctant to do. But here, firms know that all firms are
also adjusting their price at the same time. Thus firms' real prices will not change if they fully adjust and
thus they do so.

Problem 7.4
The price set by firms in period t is
(1) xt = (pit* + Et pi,t+1*)/2 = [(mt + (1 - )pt ) + (Et mt+1 + (1 - )Et pt+1 )]/2,
where we have used the fact that p* = m + (1 - )p. Since pt = (xt + xt-1 )/2 and Et mt+1 = 0, equation (1)
can be rewritten as
(1   )( x t  x t 1 )  (1  )( x t  E t x t 1 ) 2
(2) x t   m t   ,
2 2
which simplifies to
 m t (1   )( x t 1  2 x t  E t x t 1 )
(3) x t   .
2 4
Solving for xt yields
(4) xt = A(xt-1 + Et xt+1 ) + [(1 - 2A)/2]mt ,
1 1 
where A  .
2 1 

We need to eliminate Et xt+1 from the expression in (4). As in the text, it is reasonable to guess that xt is a
linear function of xt-1 and mt , or
(5) xt =  + xt-1 + mt .
We need to determine whether there are actually values of , , and  that solve the model. As explained
in the text, each price equals m in the flexible-price equilibrium. In light of this, consider a situation in
which xt-1 and mt both equal zero. If period-t price-setters also set their prices to mt = 0, the economy is at
its flexible-price equilibrium. In addition, since m is white noise, the period-t price-setters have no reason
to expect mt+1 to be on average either more or less than zero, and hence no reason to expect xt+1 to depart
on average from zero. Thus in this situation, pit* and Et pit+1* are both equal to zero and so price-setters
would choose xt = 0. In summary, it is reasonable to guess that when xt-1 = mt = 0, xt = 0. In terms of
equation (5), this condition is
(6) 0 =  + (0) + (0),
or simply  = 0. Thus equation (5) becomes
(7) xt = xt-1 + mt .

Our goal is to find values of  and  that solve the model. Since equation (7) holds each period, it implies
that xt+1 = xt + mt+1 . Thus the expectation as of time t of xt+1 is xt since Et mt+1 = 0. Using equation
(7) to substitute for xt yields
(8) Et xt+1 = 2 xt-1 + mt .
Substituting equation (8) into equation (4) gives us
(9) xt = A(xt-1 + 2 xt-1 + mt ) + [(1 - 2A)/2]mt ,
which implies
(10) xt = (A + A2 )xt-1 + {A + [(1 - 2A)/2]}mt .

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 Solutions to Chapter 7 7-7

The coefficients on xt-1 and mt must be the same in equations (7) and (10). This requires
(11) A + A2 =  ,
and
(12) A + (1 - 2A)/2 = .
Equation (11) is the same as equation (7.38) in the text for the version of the model in which m follows a
random walk. The solution to this quadratic is thus given by
1 
(13)   .
1 

Solving for  in equation (12) yields

(14) (1 - A) = (1 - 2A)/2.
From equation (11), dividing through by  and rearranging, gives us 1 - A = A. Substituting this
expression into equation (14) gives us
1  2A 
(15)   .
2 A
Substituting equation (15) into equation (7) yields
1  2A 
(16) x t   x t 1  mt .
2 A
Thus equation (16) with  given by equation (13) solves the model.

We can now describe the behavior of output. Using the definitions of A and , some simple algebra
allows us to rewrite equation (16) as
2
(17) x t   x t 1  m t   x t 1  Cm t ,
(1   ) 2
2
where we have defined C  .
(1   ) 2

Since yt = mt - pt and pt = (xt + xt-1 )/2 we have

(18) yt = mt - [(xt + xt-1 )]/2.
Substituting equation (17), and equation (17) lagged one period, into equation (18) yields
(19) yt = mt - [(xt-1 + Cmt + xt-2 + Cmt-1 )/2],
or simply
(20) yt = mt - pt-1 - [(C/2)mt ] - [(C/2)mt-1 ],
where we have used the fact that pt-1 = (xt-1 + xt-2 )/2. Now since yt-1 = mt-1 - pt-1 , this implies
(21) yt = mt + yt-1 - mt-1 - (C/2)mt - (C/2)mt-1 .
Collecting terms yields
 C  C
(22) y t  1   m t      m t 1   y t 1 .
 2  2
Finally, since
C  1 2      1 2 
(23) 1   1  2
 2
 ,
2 (1   ) (1   ) (1   ) 2
and
C 1   (1   )(1   )   1     1
(24)     2
 2
 2
 .
2 1   (1   ) (1   ) (1   ) (1   ) 2
Using (23) and (24), equation (22) can be rewritten as

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7-8 Solutions to Chapter 7

1 2  1
(25) y t   y t 1  2
t  t 1,
(1   ) (1   ) 2
where we have substituted for mt = t and mt-1 = t-1 . Thus if the money stock is white noise, output is an
ARMA(1,1) process rather than an AR(1) process.

Problem 7.5
We could proceed as in the text and obtain equation (7.50), which holds for a general process for m, and
which is given by
 1  2A
(7.50) x t   x t 1  [ m t  (1  )( E t m t 1  E t m t  2  2 E t m t 3  )] .
A 2
When the money stock is white noise, E t m t s  0 for all s > 0. Thus equation (7.50) simplifies to
 1  2A
(1) x t  x t 1  mt .
A 2
Note that equation (1) is identical to equation (16) in the solution to Problem 7.4. As in that solution, we
could now proceed to determine the behavior of output.

Problem 7.6
(a) This conjecture is reasonable. If λ is between 0 and 1, the price level will be positive. The price level
in this formula is proportional to the money supply. As t gets larger, 1 – λ t will increase if λ is between 0
and 1 and thus the price level will rise. As t → ∞, p t → m 1; i.e. the price level approaches the money
supply in the long run. The fact that price adjustment is Calvo, with a constant fraction of prices being
adjusted each period, makes it reasonable to conjecture that the form of adjustment of the price level
involves the price level moving a constant fraction of the remaining distance to its long-run value each
period.

(b) Our conjecture is that

(1) p t  (1  t )m1 .
Substituting equation (1) and the fact that mt = m1 into yt = mt - pt gives us
(2) y t  m1  (1  t )m1 ,
which simplifies to
(3) y t  t m1 .
Substituting equation (1) applied to periods t and t – 1 into the definition of inflation, πt = pt – pt – 1, yields
(4)  t  (1  t )m1  (1  t 1 )m1 ,
which simplifies to
(5)  t  t 1 (1  )m1 .

From equation (7.60) in the text, the new Keynesian Phillips curve is given by
(6)  t  y t   E t  t 1 ,
where   [1  (1  )] /(1  ) . Substituting equation (3) for yt and the expectation of πt + 1 , using
equation (5), gives us
(7)  t  t m1  t (1  )m1 .
Then we can set the right-hand sides of equations (5) and (7) equal to each other to obtain
(8) t 1 (1  )m1  t m1  t (1  ) m1 .
Dividing both sides by t 1m1 gives us
(9) 1      (1  ) .

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 Solutions to Chapter 7 7-9

After rearranging the terms, we have the following quadratic in λ:

(10) 2  (1    )  1  0 .
The solutions to this quadratic equation are
(1    )  (1    ) 2  4
(11) 1 
2
and
(1    )  (1    ) 2  4
(12)  2  .
2
Only one of the two solutions produces reasonable results for the possible range of parameter values. For
example, consider α = 0.5, β = 1, and φ = 1. This implies that κ = 0.5, λ1 = 2, and λ2 = 0.5. The value of 2
for λ1 is not possible because it leads to a negative price, which we can see from equation (1). Thus, we
will choose λ2 as our solution.

(c) Taking the first derivative of λ2 with respect to α gives us

 
 2 1    1 2(1    )(  /  ) 
(13)   ,
  2    2 (1    ) 2  4 
 
which simplifies to
 
 2 1   1    .
(14)  1
  2    (1     ) 2
 4 
 
Note that 1     > (1    ) 2  4 and so the term in square brackets is negative. In addition,
1/2β > 0. Thus, we must determine the sign of   /   . We have
[1  (1  )]

(1  )
(15)

    .
1 
Taking the derivative with respect to α gives us
  (1   )  (1)
(16)    .
 1   2
Equation (16) simplifies to
 
  
  1   2
(17)
 1 
    .
 1   
2

Since α is between 0 and 1, 1/(1 – α)2 > 1. Then, since β is less than 1, the term in square brackets is
positive. Since φ > 0, the derivative   /   is positive. Thus, finally, we have
 
 2 1   1      0.
(18)  1
  2    (1    )  4 
2


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7-10 Solutions to Chapter 7

An increase in the fraction of firms that set new prices each period is associated with a decrease in λ,
which implies faster adjustment of the price level to the change in the money supply, according to
equation (1).

Next, we first take the first derivative of λ2 with respect to β to yield

 
    1  1 2(1    )[(  /  )  1]  (2)  (1    )  (1    ) 2  4  (2)
  2   
 2  (1    ) 2  4 
(19)  ,
 42
which simplifies to
     
(1    )   (1    )  (1    ) 2  4 
  1 1   
 2    
 (1    )  4  
2
(20)  .
 22
From equation (15), we have

(21)  1  1    0 .


As explained above, since 1     > (1    ) 2  4 , we know that

 
(1    )
(22) 1    0 , and
 (1     ) 2
 4 
 
(23) (1    )  (1    ) 2  4   0 .
 
Finally, since β is positive, we know that
     (1    )

  (1    )  (1    ) 2  4 
  1 1   
   
 (1    )  4  
2
 2
(24)  0.
 2 2
An increase in households’ discount factor is associated with a decrease in λ, which implies faster
adjustment of the price level to the change in the money supply.

Finally, taking the derivative of λ2 with respect to φ gives us

 
 2 1    1 2(1    )(  /  ) 
(22)   ,
  2    2 (1    ) 2  4 
 
which simplifies to
 
 2 1   1    .
(23)  1
 2    (1    )  4 
2

As explained above, the term in square brackets is negative and 1/2β is positive. We therefore need to
determine the sign of   /   . Taking the derivative gives us

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 Solutions to Chapter 7 7-11

 
  
  1 
(24)
 1 
    .
 1   
Since α is between 0 and 1, 1/(1 – α) > 1. Then, since β is less than 1, the term in square brackets is
positive. Since α is also positive, the derivative   /   is positive. Thus, finally, we have
 
 2 1   1    0.
(18)  1
  2    (1    )  4 
2

A decrease in φ is associated with an increase in λ. Since a decrease in φ means a higher degree of real
rigidity, this implies that greater real rigidity leads to slower price adjustment in response to the increase
in the money supply.

Problem 7.7
(a) Suppose first that the elevator is not at the top or bottom of the shaft. Now assume that the money
supply rises by a small (formally, infinitesimal) amount dm. Since pi - pi* does not equal S or -S for
anyone, no prices change. All the (pi - pi*)'s fall by dm. The elevator moves down the shaft by dm and
stays of height S. Similarly, if m falls, no prices change. The elevator moves up the shaft by dm and
stays of height S.
S
Now suppose the elevator is at the bottom of the shaft.
Assume that the money supply rises by dm. Firms that
initially have pi - pi* "just above" -S reach the barrier. They
therefore raise their price so that pi - pi* = 0. Everyone else
moves down the shaft by dm. Since the height of the
elevator was S, the top of the elevator was initially at zero.
0
In the figure at right, the horizontal lines represent "slices" of
the elevator of infinitesimal height dm. Essentially, the
firms at the bottom of the elevator jump up to the top and
everyone else moves down by dm. So the elevator does not
move or change shape. Thus, with an infinitesimal change in
m, the distribution of pi - pi* is unchanged, just as in the -S
Caplin-Spulber model.

The situation in which the elevator is at the bottom of the shaft and m falls is similar to the case in which
the elevator is not at the top or bottom of the shaft. It simply moves up by dm.

Finally, the case in which the elevator is at the top of the shaft is the reverse of the case in which it starts
at the bottom. If m falls, the elevator does not move. If m rises, the elevator moves down by dm.

(b) For an increase in m, average price is unchanged except if the elevator is at the bottom of the shaft.
In this case, the average price rises exactly as much as m. Thus, on average, increases in the money
supply increase output.

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7-12 Solutions to Chapter 7

Problem 7.8
(a) The price set by individuals at time t is
1 T 1 T
(1) x( t )   E t [ m( t   )]dt   ( t   )gd ,
T 0 T  0
where we have substituted for the fact that m(t) = gt and thus that Et [m(t + )] = g(t + ). Solving the
integral in (1) gives us
1  T 
 
T 1
T
(2)  ( t   )gd  gt  0    2
  gtT  gT 2 .
0 2  0  2
Substituting equation (2) back into equation (1) gives us the price set by individuals at time t, which is
(3) x(t) = gt + (gT/2).

The aggregate price level is the average of the prices set over the last interval of length T. Thus
1 T
(4) p( t )   x( t   ) d .
T 0
Substituting equation (3) into equation (4) yields
1 T  1 
(5) p( t )    g( t   )  gT d .
T  0  2 
Solving the integral in (5) gives us
T  T
 1   1 1  1 1
(6)   g( t   )  gT d   gt  g 2  gT   gtT  gT 2  gT 2  gtT .
0
 2   2 2  2 2
 0
Substituting equation (6) back into equation (5) gives us the price level at time t, which is
(7) p(t) = gt.

Substituting m(t) = gt and p(t) = gt into y(t) = m(t) - p(t) gives us

(8) y(t) = 0.

(b) (i) Suppose that x(t) = gT/2 for all t > 0. Then for t > T, since p(t) is just the average of the x's set
over the last interval of length T, p(t) = gT/2. Now we know that for t > T, m(t) = gT/2. Thus for t > T,
we do have p(t) = m(t). From y(t) = m(t) - p(t), this means that for all t > T, y(t) = 0, which would have
been its value in the absence of the change in policy.

Now consider the situation for some time t between time 0 and time T. From time 0 to time t, we are
assuming that individuals set price equal to gT/2. From equation (3), we know that before time 0,
individuals set price equal to gt + (gT/2). The aggregate price at time t, which is the average of the prices
set by individuals over the past interval of length T, is therefore given by
1 0  gT  t  gT   1  0  gT  gTt 
(9) p( t )     g   d     d      g   d  .
T    t T  2   0
 2   T    t T
 2  2 
Solving the remaining integral in equation (9) gives us
 0
0  gT   g 2 gT  g( t  T) 2 gT( t  T)
(10)   g   d       .
  t T
 2   2 2  2 2
  t T
Substituting equation (10) back into equation (9) and expanding yields
1  g( t  T) 2 gT( t  T) gTt  1   gt 2  2gtT  gT 2  gTt  gT 2  gTt 
(11) p( t )        ,
T  2 2 2  T  2 

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 Solutions to Chapter 7 7-13

which implies
gt 2  t 
(12) p( t )  gt   gt 1  .
2T  2T 
Thus p(t) = m(t) for t between 0 and T as well. Thus if x(t) = gT/2 for all t > 0, then p(t) = m(t) for all
t > 0, and thus output is the same as it would be without the change in policy.

(b) (ii) At time t, individuals set their prices equal to the average of the expected money supply over the
next interval of length T. We know that m(t) = gT/2 for t  T, but it is strictly less than gT/2 for t < T.
Thus individuals setting prices at some time t before T are going to set their prices less than gT/2. Why?
They will be averaging some m's equal to gT/2 with some m's less than gT/2 and so we must have
x(t) < gT/2 for 0 < t < T. For T  t < 2T, the money supply is expected to be constant at gT/2 and thus
individuals set prices equal to this constant money supply. Thus x(t) = gT/2 for T  t < 2T.

We have shown in part (b) (i), that if everyone sets prices to gT/2, p(t) = m(t) and thus y(t) = 0, which is
its value in the absence of the change in policy. But as we have just explained, individuals actually set
prices less than gT/2 for 0 < t < T. Thus the aggregate price level will be less than m(t) over the interval
0 < t < 2T. Since y(t) = m(t) - p(t), this means that output will be greater than zero during this interval.
Thus this steady reduction in money growth actually causes output to be higher than it would have been
in the absence of the policy change.

Problem 7.9
(a) From equation (7.76), the new Keynesian Phillips curve with indexation is
1 
(1)  t   t 1  E t  t 1  y t ,
1  1 
1 
where   [1  (1  )] . With perfect foresight and β = 1, equation (1) simplifies to
1  1 
1 1
(2)  t   t 1   t 1  y t .
2 2
Using the definition of inflation,  t  p t  p t 1 , and the usual aggregate demand equation, y t  m t  p t ,
we can rewrite equation (2) as
1 1
(3) p t  p t 1  (p t 1  p t 2 )  (p t 1  p t )  (m t  p t ) .
2 2
After rearranging the terms, we have an expression for pt + 1 in terms of its lagged values and mt:
(4) p t 1  (3  2)p t  3p t 1  p t 2  2m t .

(b) Consider an anticipated, permanent, one-time increase in m: mt = 0 for t < 0 and mt = 1 for all t ≥ 0.
Using the lag operator, we can write equation (4) as
(5) p t 1  (3  2)Lp t 1  3L2 p t 1  L3 p t 1  2m t .
Collecting the pt+1 terms gives us
(6) [I  (3  2)L  3L2  L3 ]p t 1  2m t ,
or
(7) p t 1  [I  (3  2)L  3L2  L3 ] 1 (2m t ) .
Then we can factor [I  (3  2)L  3L2  L3 ] as (I  a 1 L)(I  a 2 L)(I  a 3 L) and therefore write
(8) p t 1  [(I  a 1L)(I  a 2 L)(I  a 3 L)] 1 (2m t ) ,
or simply

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7-14 Solutions to Chapter 7

(9) p t 1  (I  a 1 L) 1 (I  a 2 L) 1 (I  a 3 L) 1 ( 2m t ) .

Then we can express each of (I  a 1 L) 1 , (I  a 2 L) 1 , (I  a 3 L) 1 as an infinite sum of the form

1  a i L  a i 2 L2   for i = 1, 2, and 3. Thus, we can rewrite equation (9) as
(10) p t 1  (1  a 1L  a 12 L2  )(1  a 2 L  a 2 2 L2  )(1  a 3 L  a 3 2 L2  )(2m t ) .
Then after distributing the terms for multiplication and some simplification, we find the resulting path of
pt is given by
(11) p t 1  [1  (a 1  a 2  a 3 ) L  (a 1a 2  a 1a 3  a 2 a 3  a 12  a 2 2  a 3 2 )L2  ](2m t ) .

Problem 7.10
We will first derive the hint given in the problem. With partial indexation, the average (log) price in
period t of firms that do not review their prices is p t 1   t 1 . Since fraction (1 – α) of firms do not
review their price and fraction α set their price equal to xt, the average price in period t is given by
(1) p t  x t  (1  )(p t 1   t 1 ) .
Subtracting pt -1 from both sides of equation (1) gives us
(2) p t  p t 1  ( x t  p t 1 )  (1  )  t 1 .
Adding and subtracting αpt to the right-hand-side of equation (2) yields
(3) p t  p t 1  [( x t  p t )  (p t  p t 1 )]  (1  )  t 1 .
Since  t  p t  p t 1 , we can rewrite (3) as
(4)  t   ( x t  p t )   t  (1  )  t 1 .
Collecting the terms in πt gives us
(5) ( x t  p t )  (1  ) t  (1  )  t 1 .
Thus, finally, we arrive at the hint:
1 
(6) x t  p t   t   t 1  .


Equation (6) represents one key equation in our solution. The second key equation will be an expression
analogous to equation (7.75). Intuitively, from period t to period t + 1, the firm will adjust "γ for 1" to
inflation in period t. The firm would prefer not to adjust to πt at all, though, because given pt, πt has no
effect on the profit-maximizing price. Also, from t to t + 1, the firm will not adjust at all to expected
inflation in period t + 1. The firm would like to adjust one-for-one, though, because given pt , πt+1 moves
the proft-maximizing price one-for-one. Thus, we can conjecture that the analogue to equation (7.75) will
be:
(7) x t  p t  [1  (1   )]  y t  (1  )E t [ x t 1  p t 1 ]  E t [ t 1 ]   t  .

In order to derive (7), we need to generalize equation (7.13) to discounting and to the fact that the price
changes between reviews. We will denote the price the firm sets as xt and allow zt+j(xt) to denote the price
of a firm setting xt at time t and not getting a chance to review before period t + j. Thus, the analogue to
equation (7.13) is
 1 
2 
 2
(8) min   jq j E t  z t  j ( x t )  p *t  j  .


xt j0

Since fraction (1 – α) of firms get to review their price each period, q j  (1  ) j . With partial indexation,
we have

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 Solutions to Chapter 7 7-15

x t for j  0

(9) z t  j ( x j )   j1
 t    t   for j  1.
x 
  0
The profit-maximizing price in period t + j is given by
p t   y t for j  0
* 
(10) p t  j   j
p
 t    t     y t  j for j  1.
 1
Thus, we can rewrite the minimization problem as
  j1 j  
2
1 j 1
(11) min x t  (p t   y t )    (1  ) E t  x t     t    p t    t     y t  j   .
2 j
xt 2 j1 2  0 1  

The first-order condition for xt is given by
  j1 j 
(12) x t  (p t   y t )    j (1  ) j E t  x t     t    p t    t     y t  j   0 .
j1   0 1 
We can collect the (xt – pt) terms and rewrite equation (12) as
   j1 j 
(13)   j (1  ) j (x t  p t )   y t    j (1  ) j E t     t      t     y t  j  .
j0 j1   0 1 
Since β(1 – α) < 1, the sum on the left-hand-side of equation (13) converges to {1 /[1  (1  )]}( x t  p t )
and so we can write
   j1 j  
(14) x t  p t  [1  (1  )]  y t    j (1  ) j E t     t      t     y t  j   .
 j1   0 1  

Equation (14) holds for all periods. Expressing it for period t + 1, multiplying both sides by β(1 – α), and
taking the expectation of the resulting expression as of period t gives us
(1   )E t [ x t 1  p t 1 ] 
(15)    j1 j  
[1  (1  )] (1   )  E t [ y t 1 ]   (1  ) j (1  ) j E t     t 1     t 1    y t 1 j  .
 j1   0 1  
Changing the subscripts on the summations allows us to write
(1  )E t [ x t 1  p t 1 ] 
(16)    j1 j  
[1  (1  )] (1  )  E t [ y t 1 ]    j (1  ) j E t     t      t     y t  j  .
 j 2  1  2  

We now want to expand equation (14) so that we express xt – pt as several terms plus the expression given
by equation (16). That is, we can write equation (14) as
  0    0 
x t  p t  [1  (1   )] y t  (1  )E t     t       j (1  ) j E t     t    
   0  j2   0 
(17)
1  1  
(1  )   t      j (1  ) j E t    t      (1  )E t [ x t 1  p t 1 ].
1 j2 1  
Since β(1 – α) < 1, we can write equation (17) as

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7-16 Solutions to Chapter 7

 (1  ) (1  ) 
(18) x t  p t  [1  (1   )] y t  (  t )  E t [ t 1 ]  (1  )E t [ x t 1  p t 1 ].
 1  (1  ) 1  (1  ) 
Finally, equation (18) simplifies to equation (7), as desired:
(7) x t  p t  [1  (1   )]  y t  (1  )E t [ x t 1  p t 1 ]  E t [ t 1 ]   t  .

We can now use equations (6) and (7) to solve the problem. Setting the right-hand sides of (6) and (7)
equal to each other gives us
1 
(19)  t   t 1   [1  (1  )]  y t  (1  )E t [x t 1  p t 1 ]  E t [ t 1 ]   t  .

Expressing equation (6) for period t + 1 and taking the expectation as of period t gives us
1 
(20) E t [ x t 1  p t 1 ]  E t [ t 1 ]   t  .

Substituting equation (20) into equation (19) yields
1 
(21)  t   t 1   [1  (1  )]  y t  (1  )1   E t [ t 1 ]   t   E t [ t 1 ]   t  .
   
Equation (21) simplifies to
1 
(22)  t   t 1   [1  (1  )]  y t  (1  ) E t [ t 1 ]   t  .
 
Multiplying both sides of equation (22) by α/(1 – α) and adding γπt+1 to both sides of the resulting
expression yields

(23)  t   t 1  [1  (1  )]  y t   E t [ t 1 ]   t  .
1 
Collecting terms in πt gives us

(24) (1  ) t   t 1  E t [ t 1 ]  [1  (1  )]  y t .
1 
Finally, the new Keynesian Phillips curve with partial indexation is given by
1  1 
(25)  t   t 1  E t [ t 1 ]  [1  (1  )]  y t .
1   1   1   1  

In the special case in which γ = 0, equation (25) simplifies to


(26)  t  E t [ t 1 ]  [1  (1   )]  y t ,
1 
which is equivalent to equation (7.60), the new Keynesian Phillips curve.

In the special case in which γ = 1, equation (25) simplifies to

1  1 
(27)  t   t 1  E t [ t 1 ]  [1  (1   )]  y t ,
1  1  1  1 
which is equivalent to equation (7.76), the new Keynesian Phillips curve with full indexation.

Problem 7.11
(a) Since e i is the probability that a price path set at time t is still being followed at time t + i, then we
can let  (i)  1  e  i be the probability that a firm has had an opportunity to change its price path
between t and t + i. Then similar to equation (7.80) we can write
(1) (i)[(1  )a (i)  ]  a (i) .
Solving for a(i) gives us

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 Solutions to Chapter 7 7-17

  (i)
(2) a (i)  .
1  (1  ) (i)
Substituting our expression for λ(i) into equation (2) yields
(1  e i )
(3) a (i)  .
1  (1  )(1  e i )

(b) (i) Reasoning analogous to that used to derive equation (7.83) gives us
(4) y( t )  [(1  a ( t )](gt ) .
Substituting equation (3) for a(t) into equation (4) gives us
 (1  e  t ) 
(5) y( t )  1   (gt ) .
 1  (1  )(1  e t ) 
Equation (5) simplifies to
e  t
(6) y( t )   gt .
1  (1  )(1  e  t )

(b) (ii) We need to find an expression for inflation, p ( t ) , for t ≥ 0. Our usual aggregate demand equation
(7) y(t) = m(t) – p(t) ,
can be rewritten in terms of the price level as
(8) p(t) = m(t) – y(t).
Because of the assumption that all firms expect m(t) = 0 for t > 0, this simplifies to
(9) p(t) = -y(t).
Taking the time derivative of both sides of equation (9) implies
(10) p ( t )   y ( t ) .

We need to take the time derivative of output, which is given by equation (6). Using the quotient rule, we
have
 (e t gt  ge t )[1  (1  )(1  e t )]  e t gt[(1  )e  t ] 
(11) p ( t )   .
 [1  (1  )(1  e t )] 2 

After rearranging the terms and simplifying, we arrive at the following expression for inflation:
ge  t [(1   t )  (1  )(1  e t )]
(12) p ( t )  .
[1  (1  )(1  e t )] 2
Since ge  t and [1  (1  )(1  e t )]2 are both positive, inflation will be negative if
[(1   t )  (1  )(1  e t )] is negative. Since 0    1 , then (1  e t )  0 for large enough t. In
addition, since (1  )  0 , then (1  )(1  e t ) > 0 for large t, or equivalently,  (1  )(1  e  t )  0
for large t. Since (1   t )  0 for t  1 /  , the answer to this question is yes and inflation during the
transition to the new steady state will be negative for large enough t.

(b) (iii) With the assumption that φ = 1, equation (6) becomes

(13) y( t )  e  t gt .
To find the time at which output reaches its lowest level, we need to set dy(t)/dt = 0 and solve for t. Thus,
we have

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7-18 Solutions to Chapter 7

dy( t )
(14)  e t gt  e t g  0 ,
dt
which implies
(15) ge  t (t  1)  0 .
Because ge t is nonzero, our solution is
1
(16) t*  .

To check whether this is a minimum, we take the second derivative

d 2 y( t )
(17)    2 e t gt  e t g  e t g 1 ,
2 t
dt t
1


which simplifies to
d 2 y( t )
(18)   e t g ( 2   t ) t  1 ,
2
dt t
1 

and, finally
d 2 y( t )
(19)  e 1g  0 .
2
dt t
1

Thus, output does reach a minimum at t* = 1/α.

To determine the time at which inflation reaches its lowest level, we need to take the first derivative of
expression (10) with respect to time, set it to zero, and solve for t. That is, we need to solve
dp ( t ) dy ( t )
(20)  0.
dt dt
From equation (18), we already know that dy ( t ) / dt  e t g (2  t ) and so we have to solve
(21)  e t g (2  t )  0 .
Because e t g is nonzero, our solution is
2
(22) t*  .

To check whether this is a minimum, we know from equation (21) that
dp ( t )
(22)   e   t g ( 2   t ) ,
dt
which we can rewrite as
dp ( t )
(23)  2e t g   2 e t gt .
dt
Taking the second derivative of p ( t ) with respect to time gives us

d 2 p ( t )
(24)  2 2 e t g   2 ge t   2 gt ()e t 2 ,
2 t
dt t
2


which simplifies to

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 Solutions to Chapter 7 7-19

d 2 p ( t )
(25)   2 ge t (3  t ) 2 .
2 t
dt t
2


Thus, we have
d 2 p ( t )
(26)   2 ge 2  0 .
2
dt t
2

Thus, inflation does reach a minimum at t* = 2/α.

Problem 7.12
(a) For the case of white-noise disturbances, to find expressions analogous to (7.92)-(7.94), we start with
the three core equations given by
1
(1) y t  E t [ y t 1 ]  rt  u IS
t ,   0,

and
(2)  t  E t [ t 1 ]  y t  u t , 0    1,   0,
and
(3) rt     t   y y t  u MP
t ,    0,  y  0 .

First, we substitute equation (3) for rt into equation (1) to yield

1
(4) y t  E t [ y t 1 ]  (   t   y y t  u MP t )  ut .
IS

Substituting equation (2) for πt into equation (4) gives us
1


(5) y t  E t [ y t 1 ]  E t [ t 1 ]    y t  u t   y y t  u MP t 
 u IS
t .

We need to solve for yt. Collecting terms gives us

     y 
(6) 1 

1
  MP

IS
 y t  E t [ y t 1 ]  E t [ t 1 ]    u t  u t  u t .

 
Multiplying both sides of equation (6) by  /(      y ) gives us

(7) y t 

      y
E t [ y t 1 ] 
1
      y

 E t [ t 1 ]    u t  u MP
t   
      y
u IS
t ,

which we can rewrite as

(8) y t 
1
      y

 E t [ y t 1 ]    E t [ t 1 ]   u t  u MP
t   u IS
t . 
Next, we incorporate the fundamental solution of E t [ y t 1 ]  0 and E t [ t 1 ]  0 , giving us

(9) y t 
1
      y
 u IS   MP
t  u t  u t . 
Now substitute equation (8) for yt into equation (2) to yield the following expression for inflation:
(10)  t  E t [ t 1 ] 

      y

 E t [ y t 1 ]  E t [ t 1 ]   u t  u MP IS 
t  ut  ut . 
Collecting the terms in Et[πt+1] and u t gives us

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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
7-20 Solutions to Chapter 7


(11)  t  1 
  
 E t [ t 1 ] 


 E t [ y t 1 ]  u MP
t   u IS

t  1      
u t .
        y        y         y 
Since
      y
(12) 1   ,
        y        y
we can rewrite equation (11) as
(13)  t 
1
      y

  E t [ y t 1 ]   u MP
t    u IS 
t  (   y )( E t [  t 1 ]  u t ) . 
Substituting the fundamental solution of E t [ y t 1 ]  0 and E t [ t 1 ]  0 into equation (13) yields

(14)  t 
1
      y

  u IS  MP
t  (   y ) u t   u t . 
Next, we can substitute equations (9) and (14) for output and inflation into equation (3) to obtain an
expression for the real interest rate, given by

(15) rt 

     y

  u IS  MP
t  (   y ) u t   u t 
y

     y
 u IS 

MP
t  u t  u t  u MP
t . 
Collecting terms gives us
(16) rt 
1
     y

(      y )u IS  MP
t  (     y    y ) u t  (     y     y   ) u t , 
which simplifies to
(17) rt 
1
     y

 (      y )u IS  MP
t    u t   u t . 
Equations (9), (14), and (17) are analogous to (7.92)-(7.94).

Because we are assuming that all constants are positive, we obtain the following signs on the impacts of
the unfavorable inflation shock:
 yt 
(18) 
 0;
 ut      y
 t   y
(19)   0;
 u t      y
and
 rt  
(20)   0.
 u t      y
Thus, an unfavorable inflation shock reduces output and increases both inflation and the real interest rate.

(b) The shocks follow independent AR-1 processes:

(21) u IS IS
t   ISu t 1  e t ,
IS
 1   IS  1 ;
(22) u t    u t 1  e t ,  1    1 ;
and
(23) u MP
t   MP u MP MP
t 1  e t ,  1   MP  1 ,

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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
 Solutions to Chapter 7 7-21

where eIS, eπ, and eMP are white-noise disturbances that are uncorrelated with one another. To solve the
model using the method of undetermined coefficients, we guess that the endogenous variables are linear
functions of the disturbances. We can therefore write output and inflation as

(24) y t  a ISu IS MP
t  a  u t  a MP u t ,
and

(25)  t  b ISu IS MP
t  b  u t  b MP u t .

Since (24) and (25) hold for all t, we can express output and inflation in period t + 1 as

(26) y t 1  a ISu IS MP
t 1  a  u t 1  a MP u t 1 ,
and

(27)  t 1  b ISu IS MP
t 1  b  u t 1  b MP u t 1 .
Now substitute equations (21) through (23), expressed in period t + 1, into equations (26) and (27) and
take the expectation of the resulting expressions as of period t to yield

(28) E t [ y t 1 ]  a IS ISu IS MP
t  a   u t  a MP  MP u t ,
and

(29) E t [ t 1 ]  b ISISu IS MP
t  b   u t  b MP  MP u t .

We can now substitute the expressions for E t [ y t 1 ] and E t [  t 1 ] , along with equations (24) and (25)
into equations (8) and (13). We obtain the following expression from equation (8):
  
a ISu IS MP
t  a  u t  a MP u t  (a ISISu IS MP
t  a   u t  a MP MP u t )
      y
(30)


      y
(b ISISu IS  MP
t  b   u t  b MP  MP u t ) 
1
      y
 u IS 
 MP
t   u t  u t . 
We also obtain the following expression from equation (13):
  
b ISu IS
t  b  u t  b MP u t
MP
 (a IS ISu IS MP
t  a   u t  a MP MP u t ) 
      y
(31)
(   y )
      y
( b ISISu IS  MP
t  b   u t  b MP  MP u t ) 
1
     y
  u IS   MP
t  (   y ) u t   u t . 

The two sides of (30) must be equal for all values of u IS MP IS
t , u t , and u t . Thus the coefficients on u t ,
u t , and u MP
t on the two sides must be equal. Similarly for equation (31). Once we have solved for the
a's and b's, equations (24) and (25) tell us the behavior of output and inflation. We can then substitute
those solutions for πt and yt into equation (3) to solve for the real interest rate.

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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Other documents randomly have
different content
De gamle Bolværksgader
om lønlige Kanaler,
Børstaarnets Dragehaler,
Slotspladsens Lygterader;
bag Kirke-Gravkapellet
det skumle Kristiansborg!
— Hér var det, at Farvellet
greb mig som en Sorg.

Min Ungdoms Minder ruger,

og glemte Længsler taler
langs disse graa Kanaler
med lukte Pakhus-Luger.
— Gaderne kan fortælle
om Holland og om Flandern,
om gammel Købmands-Vælde,
om Tordenskjold og van Mandern.

Dèr henne glimter Ruden,

hvor jeg har Hjem og Virke,
og under Frelsers Kirke
en grønlandsk Plads med Skuden;
køl-stærk og isforhudet
trodser den sig mod Nord,
— naar den har Afsked tudet,
saa er jeg med ombord.

Da vil der rinde Tider,

før atter jeg betræder
de skæbnesvangre Steder,
hvor Kampens Vaaben bider.
Jeg elsker Storstads-Sejren,
og skøndt jeg skræmt forlod den
og afskyer Klike-Lejren,
drages jeg dog imod den.

J d t t t kill
Ja, det er svært at skilles
fra disse gamle Gader;
jeg elsker og jeg hader
det Liv, der her udspilles.
Her blev mit Hjærte prøvet.
her led jeg Sorg og Savn,
— o, jeg gik tidt bedrøvet
ud gennem Kristianshavn.

Men der er Morgentimer,

naar over Tagstens-Vrimlen
Vaarsolen rødner Himlen,
mens alle Klokker kimer,
— da sprang jeg fra mit Leje
og hilste Spir og Slotte
og higed stolt mod Veje,
som ingen Fod betraadte!

Og der er høstligt svale

og skumrings-dunkle Nætter,
naar Tivolis Raketter
som en Komét med Hale
paa Slotsruinens Rygge
nedstraalte gyldne Drys,
mens skjult i Søjlers Skygge
jeg stjal et Kærrest-Kys!

Og naar i Vintrens Taage

hver gothisk Husgavl dølges,
da véd jeg to, som følges
rundt om i Havnens Kroge:
dèr leves Glædens Røre,
dèr lides Livets Kvaler
bag gamle Egedøre
og forsirede Portaler.

De gamle Stokværks-Gaarde
 g
langs lønlige Kanaler
og Børsens Dragehaler
bag Havnens travle Aare
— her leved jeg og lærte,
herhen vil jeg paany,
thi ene her mit Hjærte
slaar for den store By!
II

Du altfor store By til dansk Behov,

Hjemstavn for Livs-Tilværelsens bitre Kampe,
— jeg knyttede mine Hænder som i Krampe
den første Nat, jeg ved dit Hjærte sov!

Dèr midt i Mylret galdt den Stærkes Lov,

om Tag og Tind steg Offerblodets Dampe,
— saa hyggede jeg mig ved min Stuelampe
angst for den onde Verdens Hestehov.

Men Larmen genlød i mit stille Kammer,

snart kendte ogsaa jeg mig vaabenfør
— og vandt de første Nederlagets Skrammer ...

Du skæbnesvangre By om Havn og Søer,

du gav mig Kampens Liv og Sejr og Jammer,
— jeg længes efter dig som aldrig før!
FÆDRELANDSSANG
Mit gode danske Fædreland,
mit Hjem, min Daad, mit sidste Suk,
en ringe Plet paa Globens Rand,
i Verdens Alt en Draabe Dug!
Og er end dette Danmarks Navn
ukendt af mangen Jordbeboer,
min Stolthed er det og mit Savn,
herfra udgaar mit Skæbnespor,
her fik jeg Liv, her døde Mor.

Og dette Land, jeg har saa kært,

min unge Elskovs Brudeseng,
hvor er det blevet misregért
og pint af fremmed Fyrsteslæng!
I slog vor Ret, udaad vor Marv
og leved selv i Sus og Dus,
lod Vold og Vælde gaa i Arv,
udødelige Kongehus,
vort sunde Legems Snyltelus!

Jeg hader Kongemagt og Krig,

og jeg vil ikke ofre Blod
og ikke ligge Valplads-Lig
— men Livets Krig udstaar mit Mod!
Hver den, som øger Livets Værd
ved Brødets Kamp som Arbejdsmand,
i Videnskab, paa Forskerfærd,
ad Kunstens Baner, hel og sand,
han bløder for sit Fædreland.

Ja, dette dyre Blod har flydt,

fra Danmarks gamle Land blev skabt;
en tusind-tunget Vé har lydt,
naar disse Daadens Mænd gik tabt.
Men Fyrsten sad paa Tronens Stol
fra Folkets Liv og Tanker fjern
som Maanens Fjæs fra Livets Sol,
forskanset bag »Guds Naade«s Værn,
hans Gunst var Guld, hans Vrede Jærn.

O, Danmark! Mangen ydmyg Nar

lod hæfte Kongens Guld paa Bryst,
— men tifold stolt sit Hoved bar
hver ukøbt Mand i Dagens Dyst.
Om Danmark som en Frihedsstat,
hvor Folket raader Folkets Kaar,
hvor Kongen og hans Hof-Etat
af Folkets Naade Aftægt faar,
dog lige dristig Drømmen gaar.

Ja, drøm dig frem til Republik,

saa alle Evners Fylde naas,
før du skal tømme Dødens Drik
og af et »Stor-Evropa« flaas.
Det Kongens Danmark, vi har troet
var Flammen i vor Hjærtebrand,
vil dø og blive mosbegroet,
men leve mellem Mand og Mand
vil Folkets gamle danske Land.

Mit Land, mit Liv, min Skæbnes Gud,

hvor jeg blev født, hvor jeg vil dø,
naar jeg har adlydt Livets Bud
som Blomsterkalken, der gav Frø,
du skønne Land af Øer og Næs
med Oldtidsskov paa Bakkedrag,
med Aa og Eng og frodigt Græs
og Lyngklit ud mod Bølgeslag,
med frigjort Folk som Fremtidssag!

O, lad mig se endnu en Gang

mit jydske Hjem, min Far, min Brud
og høre Hedelærkens Sang,
og høre Hedelærkens Sang,
naar Klokkelyngen springer ud.
O, lad min Baad en stormfuld Dag
for stærke Sejl naa hjem i Havn,
— ja, flød jeg blot til Strand som Vrag,
min Last forlist, forglemt mit Navn,
saa fandt jeg dog min Fødestavn!

Mit gode danske Fædreland

du ejer alt mit Hjærteblod,
hjem til din lave, lyse Strand
gaar altid glad min Aand og Fod.
Og er du end et usselt Fnug,
en ukendt Plet paa Globens Rand,
udpint til Armod, Had og Suk
af fremmed, lovløs Fyrstestand,
du er mit Land, mit dyre Land!
 VENNER
TIL L. C. NIELSEN OG VALDEMAR
NEIIENDAM
I

Hvad er ærligt Venskab? Livets Salt!

Det har krydret mig de ferske Retter,
Mennesker paa Livets Festbord sætter,
været Gærstof i den vamle Malt.

Der var Tider, hvor jeg nød det alt:

sukret Bagværk, som kun daarligt mætter,
søde Vine, der gav tørre Pletter,
men den Levevis for Brystet faldt.

Da blev syrlig Mosel Yndlingsvinen,

naar jeg valgte anden Drik end Vand,
høstlig sval den flød bag Glassets Rand.

Ogsaa den har tændt min Sjæl i Brand,

men afklaret var jeg da: en Mand,
der aad ikke Brød blot for Rosinen.

II
Venner! I gav Surdejg til mit Brød.
Jeg slog op mer, end jeg kunde bage,
jydsk var Kornet, kunde Hvermand smage,
og af Lyngbaal Ovnen hed og rød.

Jeg var ung og endnu grøn af Lød.

Mestrene gav kandiseret Kage,
skulde Kundekresen da beklage
Sukkermanglen i det Værk, jeg bød.

Ung og grøn kom jeg til Hovedstaden,

ikke én af Fagets Folk jeg kendte,
aabned angst min Bod i Sidegaden.

Men dèr var det, at det slemme hændte,

I gav mig paa Surdejg Appetit,
og saa gik Bedriften snart fallit.

III
Salt og Surdejg, bedske Krydderier
blev mit Væsen og mit Kald en Tugt.
— Ikke mange Folk ser noget smukt
i de livsens-bitre Poesier.

Men den kloge Mand er den, der tier,

lige glad om Værket blot blir slugt
af de Faa, hvem det er udsøgt Frugt,
og som hader Kling-Klang-Melodier.

Han er Digter og kan ikke ænse,

om han overskred den Smagens Grænse,
som er gængs for dannede Poeter.

Maaske saares alle hans Bekendte,

men som Literaturens Dumme-Peter
vil han ikke sine Laurbær hente.

IV
Aldrig skal i Kunst vort Liv opstaa,
om vi vikler os i Hensyns-Vævet;
— men jeg véd, at vi har alle bævet,
hvor de store Opgør forelaa.

Men hver den, som paa Akkord vil gaa,

naar det blir af Slægt og Omgang krævet,
og som ikke faar sit Livsværk hævet
op, hvor Himlen hvælves høj og blaa,

han maa altid give Køb og lyve,

han er Larven, der skal aldrig flyve
sommerfugle-fri til Blomstens Kube.

Kunstens Ilddaab volder Sorg og Sukke,

skiller al hans Kres i Faar og Bukke,
er ham ene Vej til Sjælens Grube.

V
Kunst er Sandhed! I er begge sande.
Kunst er Liv og Kunsten dyrekøbt,
derfor staar I begge to som støbt,
møder Grin og Svig med aaben Pande.

I er Lys ud over plumre Vande,

Luftning, hvor den klamme Gus har svøbt,
alt jert Arbejd bliver smærte-døbt
og gaar derfor virkningsløst om Lande.

Thi vi kender dansk Moral og Mode:

— Kunsten er det skønne, ædle, gode
i sødladen, smærtefri Servering ...

Lad os Hyl i Harmonien blande:

Kunst er ikke Tossernes Formering,
Kunst er Liv — det dybt personligt sande!

VI
Venner, I har levet denne Lære
og før nogen rakt mig Broderhaand,
Næring drog vi af hinandens Aand;
hvor vi fulgtes, var der godt at være.

Alt, vi leved, saa' vi Frøkorn bære,

rodfast Egen skød af spinkel Vaand;
skilte ad skal just vort Venskabs-Baand,
fri for Egennytte, styrket være!

Fyldt af Udvé følger hver sin Bane,

Farten det er Livet, Kunstens Lods,
lutret naar vi hjem til fælles Fane.

Vi, som véd hinandens Dyd og Fejl,

er ej Slaver af hinandens Ros,
derfor ses vi — og ser os i Spejl!

VII
Kunstnere! Du Digter og du Maler!
I, mit Hjærtekalds de bedste Venner,
husker I, vi stod med bare Hænder
henrykt rige under Kaldets Kvaler?

— Vi har Hybler højt paa femte Sal'er,

vi er Folk, som Livets Trængsler kender;
men vi tror paa Lykken, naar det hænder,
at rettidigt Lejen vi betaler ...

Unge, grødefulde Foraarsfest,

oprørssvangre Tid, fuld af Skandaler,
naar vi slog de mugne Idealer!

Hver bar Skotøj efter egen Læst,

fodfri blot, som luftige Sandaler,
— hellige Tid! Du Digter! Og du Maler!

VIII
Langt, langt borte fra den Vej, I gaar,
har af Sten og Sne jeg bygt min Hule,
Ravn og Rype — Fjældets Vinterfugle —
deler trofast mine Sultekaar.

Kan I huske vore Ungdomsaar,

da vort Eje var en ringe Smule!
— Aldrig dog som her i yderst Thule
var jeg stædt i saa fortrykte Kaar!

Heller aldrig var jeg rig som her:

se! Jeg har Nomadens gyldne Drømme
og min Friheds Verdensherredømme,

rigest dog ved dem, som jeg har kær,

aldrig stod jeg Jer saa hjærte-nær
som i Armods-Tid blandt Bræens Strømme!
DANSKE MÆND
Hørup! Den tavseste Mund i vort Land,
stærke, kloge, besynderlige Mand!

Vi, som holdt af ham og aldrig kan glemme

hans smilende Mund, husker næppe hans Stemme.

Den Mund, som før havde flammet saa tidt,

var ikke i trodsig Foragt sammenbidt,

den tav blot og var som et fint lille Smil

over Menneskers Dumhed — og undte sig Hvil.

— Han var graanet den Gang, jeg traadte ham nær.

Nær! Nej, en Afgrund der var mellem hver.

Ikke at han var stor mod den unge!

Jeg fatted blot ikke den tavse Tunge ...

En Nytaarsdag, jeg skrev ved mit Bord,

kom han gaaende gennem vort Kontor.

Jeg vilde ham ønsket paa gammel Skik

»glædeligt Nytaar« — men mødte hans Blik,

et mildt og elskværdigt — han var jo saa god —

men det missede lidt, og jeg tabte mit Mod.

For dette gaadefuldt smilende Blik

slog Tankerne Sludder og Munden Klik.

Aldrig fik jeg ham ønsket noget godt,

forundret tav jeg — han smilte blot ...

Nu véd jeg, hvad dette Smil betød,

begreb det, længe før han var død:

»Min unge Ven! Over den hele Jord

de ærligste Ønsker faar aldrig Ord «
de ærligste Ønsker faar aldrig Ord.«

»Den Ven, der ønsker mig godt, er en Taabe;

handle skal han i Stedet for haabe.«

»Folk, som er enige, samtaler nødig;

overfor Fjender er Ord overflødig!« ...

— Bag Hørup, den utilgængelige Mand,

stod vel vort danskeste Hjærte i Brand.

Men han gennemskued alt, saa Folk blev nøgne,

han elsked Sandhed, bekæmpede Løgne,

var derfor saa inderlig frygtet og forhadt

og savnet, da han havde sin Plads forladt —

denne tavse Mund, disse talende Øjne.

Hørup er som Minister endt,

Georg Brandes blev stats-anerkendt.

Det er just intet logisk Punktum

for Mænd, der gnistrer af evig Ungdom,

medmindre vi danske ikke mere

vil lade den hædrede Alderdom regere!

— Brandes! Jeg skrev en Gang, han var Gud.

Da skammede mine Venner mig ud.

Og Guden selv var saa venlig at lade,

som om han ikke læste de Blade.

Det ligger nu langt tilbage i Tiden;

desværre, jeg har ikke udviklet mig siden.
Det er jo dog ellers svært moderne
at haane sin forrige Ledestjerne,

at sparke til den, der har lært os at gaa.

Brandes er blevet sparket som faa.

For mig staar aldrig saa stærk en Glans

af en Himmelens Stjerne som af hans.

Men der sidder jo rundt i den danske Stat

mangen overbevist Renegat.

Ja, hvor var der Jubel i Fjendernes Lejr,

ved Renegaterne haabed de Sejr.

Men Skæbnen har sig forunderlig vendt,

nu er Brandes stats-anerkendt ...

— Alligevel! Han er den samme som før

og bliver bare sig selv, til han dør.

De fanger ham aldrig med Statsløn og Tittel,

han er Lucifer, altid i Arbejds-Kittel,

en Samfundets evigt lutrende Ild,

en Ungdommens Sokrates, naar den foer vild.

Stærk som Døden, der trued ham tidt,

har for de dristigste Tanker han stridt.

Tanker, der har omformet os alle,

som helt har sejret, naar han maa falde,

sejret selv dèr, hvor man nødigst indrømmer det:

Bægret er bedskt — men se, hvor de tømmer det!

— Blot hos det alleryngste Kuld

er Brandes ej længer lødigt Guld.
 j g g

De Folk har i egne Indvolde set

og set: at de selv er den ny Profet.

Og Menneskeheden hungrende bier

paa det yngste Danmarks ny Profetier.

Kanske har de lydt, naar jeg kommer hjem;

— ak, tænk om jeg saa er for gammel for dem!

For Brandes bliver jeg aldrig for gammel,

jeg sidder nu som før ved hans Skammel.

Han vakte min Sjæl, han skrev dens Bud,

— jeg var ung en Gang og kaldte ham Gud.

Maaske er jeg konservativ af Nemme,

for han fylder mig her, som han fyldte mig hjemme.

Jeg bringer ham Tak og Hyldningstegn

fra Jordens nordligst beboede Egn.

Vinternatten gaar lykkeligt hen:

jeg lever med Georg Brandes igen

med ham og Hørup — de danske Mænd.

KLASSICISME
Puh! Alt det Slid vi ofrede Latinen og det Græske,
de tusind spildte Timer, hvis Gavn vi aldrig ser,
al den forlorne Dyrkelse af Cicero og Homér,
den psevdo-klassiske Nippedrik af næringsfattig Vædske!

Bevares: Filologerne af Fag! Lad dem florere!

Men hvorfor skal hver dansk Student indsprøjtes klassisk Aand
af Skolens Straalemestre, der lægger den døde Haand
paa aandløst Glose-Terperi. Det kalder man at studere!

Lær os at tale Sprogene, som nu behersker Kloden.

— I Kraft af min Eksamen tror jeg mig Pokkers vis,
men staar en Dag umælende i London eller Paris
— jeg vigtige danske Student! Et Offerlam for Moden!

Jeg véd en duelig Købmand, der siger om Studenter:

»Her sidder de paa Kontoret, deres Eksamen er fin,
men ingen af dem kan skrive et brugeligt Brev til Berlin,
— jammerligt saa deres Lærdom giver usle Renter!«

Men se til de Skolemestre, de kror sig selv-henrykte,

de repeterer Pensa, til de er paa Gravens Rand,
— ikke en Brøkdel af dem har set et fremmed Land,
blot »dunkle Steder« hos Homér — med Leksikon som Lygte!

Men de gjorde god Eksamen; det var fra Arilds Tider

alle Hjemmefødningers eneste Prærogativ.
Nu er det dog paa Tide at kræve Luft og Liv:
der er i den danske Ungdom Tusinder, som lider.

For Verden ligger jo aaben. Grænseskellene falder;

den, der vil belære andre, maa ud i Tidens Strøm.
Vi sulter ihjel derhjemme af bare daadløs Drøm,
vi evigt klassiske Mumier af ærværdig Alder.

Dèr sidder vi pænt i Skolen og lærer Spartas Love,

men kender ikke Formerne for vor egen Stat.
men kender ikke Formerne for vor egen Stat.
Er ikke denne Borgernes Udklækning desperat!
Hvor længe skal i klassisk Marmor vi livløst sove?

Gaa ud i den vide Verden, du Fremskridtets unge Danske,

som trænger til ny Impulser, til friere Overblik,
det gjorde vor egen Brandes, og Gudskelov at han gik,
rigt rustet kom han tilbage — og kastede sin Handske ...

Paa Ære! Jeg vil tage mit Standpunkts Konsekvenser,

en Kætter mod Klassicismen. Jeg fik jo Livets Vink
fra Goethe, Dostojewskij, Ibsen og Maeterlinch,
Spinoza, Voltaire og Darwin, Nietsche, Renan og Spencer.

Jeg er et Tidens Barn. Jeg holder ikke Guder

bare til tom Parade i Bogskab og paa Mund,
— fremfor alt saa fordrer jeg en sand og sund
Spejling af Nutidslivet ind gennem Sjælens Ruder.

Det er ikke Kunst jeg savner hos danske Literater,

vi, I. P. Jacobsens Landsmænd, vi kan vort gode Sprog,
men vi sidder gemt derhjemme hver i sin stille Krog,
mens alt blir Elektricitet, Maskiner og Soldater.

Leve Elektriciteten! Den er Verdensaltets Nerve,

men Digterne vælger Maanen til Genstand for Poesi.
Hvorfor ikke tage de Kræfter, vi netop lever i,
og smælte dem om i Kunst. Her er Nystof at erhverve.

Vi risikerer tilsidst, at ingen gider forlægge

og ingen ænse den Kunst, der skurer de gamle Spor.
Kunst ejer det evige Liv, naar den fornyer sin Jord,
— saa lad os villige Sanser mod nye Verdner række!

Se: Jacobsen var Darwinist. Han samlede Blomster i Kæret,

alle hans Sanser blev skærpet — var det mon Kunsten til Tab?
Fællerne hjemme savner hans Sans for Naturvidenskab,
derfor er vort Verdensbegreb saa underlig uafgæret.