Unemployment and Real Interest Rates: Econometric Testing of Inflation Neutrality
roeconomics has, in its simpler characterizations, asserted three hypotheses about the economy. First, the short-run expectationsaugmented Phillips curve is vertical. Second, the real rate of interest is independent of anticipated inflation. Third, expectations are formed rationally in the sense that people use mathematical expectations conditional on available information. The three propositions together suggest the neutrality of the economy with respect to anticipated inflation. In this paper I propose a set of regression-based econometric tests of these three neutrality propositions. I carry out simple versions of these tests for the postwar American economy. Such neutrality propositions distinguish the modern neoclassical school from the traditional American Keynes-Hicks school of macroeconomics. It is true that these state
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