On January 29, 2013, the Federal Reserve released a special statement that clarified its goals of “price stability” and “maximum employment.” Specifically, it stated that “the Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve’s statutory mandate” and that “FOMC participants’ estimates of the longer-run normal rate of unemployment had a central tendency of 5.2 percent to 6.0 percent.” Assume this statement implies that the natural rate of unemployment is believed to be 5.6%. Go to the St. Louis Federal Reserve FRED database, and find data on the personal consumption expenditure price index (PCECTPI), the unemployment rate (UNRATE), real GDP (GDPC1), and an estimate of potential GDP (GDPPOT). For the price index, adjust the units setting to “Percent Change From Year Ago”; then download the data into a spreadsheet.

a) For the most recent four quarters of data available, calculate the average inflation gap using the 2% target referenced by the Fed. Calculate this as the average of the inflation gaps over the four quarters.

b) For the most recent four quarters of data available, calculate the average output gap using the GDP measure and the potential GDP estimate. Calculate the gap as the percentage deviation of output from the potential level of output. Calculate the average over the most recent four quarters of data available.

c) For the most recent 12 months of data available, calculate the average unemployment gap, using 5.6% as the presumed natural rate of unemployment. Calculate the average unemployment gap over the most recent 12 months of data available.

d) Based on your answers to parts (a) through (c), does the divine coincidence apply to the current economic situation? Why or why not? What does this say about the sources of shocks that have impacted the current economy? Briefly explain.