Consider two groups of countries within the European Union: for the first one, inflation is the absolute target; for the other growth and decrease of unemployment is the main concern. πli (li for low inflation) is the inflation rate limit of the first group and πfu (fu for full employment) is the accepted rate of inflation for the second group. It is clear that The discussions are balanced between these two groups and no decisive arguments emerge so we can assume that they both have an equal chance to make the decision.The Philips curve is given by The decision is going to be taken in the context of an Euro Union group, the EcoFin, which will announce the economic policy for the coming years. Assume that expectations about inflation in the coming year (represented by ) are formed before the EcoFin (meaning that wages are already set). a. Solve for expected inflation, in terms of and b. If the group for full employment prevail, the rate of infla-tion () will be accepted. Given the solution for expected inflation in (a), how will the unemployment rate compare to the natural rate of unemployment? c. What is the answer if the contrary is true? d. What is the best policy then?
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