1. Explain what is meant by the central bank’s loss function. How are the central bank’s preferences reflected in the loss function? Draw the loss ‘circles’ for the cases where, (a) β = 1 (b) β < 1 (c) β > 1 In which of the three cases will the central bank reduce inflation back to target quickest after an inflation shock?
1. Explain what is meant by the central bank’s loss function. How are the central bank’s preferences reflected in the loss function? Draw the loss ‘circles’ for the cases where,
(a) β = 1 (b) β < 1 (c) β > 1
In which of the three cases will the central bank reduce inflation back to target quickest after an inflation shock?
2. Assume that α = β = 1, derive the MR curve graphically using the tangencies between the loss circles and the Phillips curves. With reference to the diagrams, explain the effect of the following (in each case, assume all other parameters are held constant):
(a) An increase in the slope of the
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