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I wanted to ask how do we give economic interpretation or meaning to expressions like the Phillips curve. So what is the economic interpretation of the Phillips curve π= Eπ + 1/α(y-ȳ) +v?

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Every equation is just a sentence written in logical abstract language. Hence, to interpret it you just need to correctly read it out. The following sentence:

$$π= E[π] + \frac{1}{\alpha}(y-\bar{y}) +v,$$

just says that inflation $\pi$ positively and linearly depends on people's expectation of what the inflation is ($E[\pi]$). It also positively and linearly depends on output gap $(y-\bar{y})$ (i.e. observed output - output at full employment), and the strength of influence of the output gap depends on parameter $\alpha$ (higher alpha means output gap is less relevant for inflation). I presume $v$ are the idiosyncratic shocks (e.g. errors) which just says that random economic shocks may further affect inflation. Moreover, the equation also shows that the relationship is additive (as opposed to let's say multiplicative relationship).

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  • $\begingroup$ Thank you very much, this was very helpful $\endgroup$
    – sofi
    Jan 13 at 16:39
  • $\begingroup$ @sofi you are welcome if this answered your question consider accepting it $\endgroup$
    – 1muflon1
    Jan 13 at 16:39
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    $\begingroup$ The equation actually says more than that, viz. inflation depends positively and linearly on these components, and that the effects are additive, and a little bit more... $\endgroup$
    – VARulle
    Jan 14 at 8:33
  • $\begingroup$ @VARulle you are right I expanded my answer, thanks for the remark $\endgroup$
    – 1muflon1
    Jan 14 at 8:55

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