Use a standard dynamic AS-AD model to explain how the macroeconomy adjusts following a favourable supply shock (vt < 0) for one period which reverts to zero for all subsequent periods. Assume that the economy starts from its long-run equilibrium. As a reminder, the DAD and DAS curves, respectively, are provided below: Y =Y - αθη 1+aly Tt = t_1+ ¢(Y - Y)+v where Y is output, πt is inflation, 0 and Oy capture the responsiveness of the central bank to inflation and output, a is the sensitivity of output to the real interest rate and is the sensitivity of inflation to the output gap. Y is the natural output level, and π* is the central bank's inflation target. [Hint: It will be helpful to work this question out using diagrams, but you are not required to provide them as part of your solutions.] -(πt - π* π*) + 1+aly Et A. (2 points) Explain the impact effect of this shock on output, inflation, and the real interest rate. B. (3 points) Explain the dynamic response of output, inflation, and interest rates in subsequent periods. Does the economy converge back to the same long-run equilibrium? C. (2 points) Explain how the central bank responds to inflation and the importance of the monetary authority following the Taylor principle. D. (3 points) How would your answer to (B) change if the shock lasted for several periods (instead of one period) before reverting to zero?
Use a standard dynamic AS-AD model to explain how the macroeconomy adjusts following a favourable supply shock (vt < 0) for one period which reverts to zero for all subsequent periods. Assume that the economy starts from its long-run equilibrium. As a reminder, the DAD and DAS curves, respectively, are provided below: Y =Y - αθη 1+aly Tt = t_1+ ¢(Y - Y)+v where Y is output, πt is inflation, 0 and Oy capture the responsiveness of the central bank to inflation and output, a is the sensitivity of output to the real interest rate and is the sensitivity of inflation to the output gap. Y is the natural output level, and π* is the central bank's inflation target. [Hint: It will be helpful to work this question out using diagrams, but you are not required to provide them as part of your solutions.] -(πt - π* π*) + 1+aly Et A. (2 points) Explain the impact effect of this shock on output, inflation, and the real interest rate. B. (3 points) Explain the dynamic response of output, inflation, and interest rates in subsequent periods. Does the economy converge back to the same long-run equilibrium? C. (2 points) Explain how the central bank responds to inflation and the importance of the monetary authority following the Taylor principle. D. (3 points) How would your answer to (B) change if the shock lasted for several periods (instead of one period) before reverting to zero?
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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![Use a standard dynamic AS-AD model to explain how the macroeconomy
adjusts following a favourable supply shock (vt < 0) for one period which
reverts to zero for all subsequent periods. Assume that the economy starts
from its long-run equilibrium.
As a reminder, the DAD and DAS curves, respectively, are provided below:
Y =Y -
αθη
1+aly
Tt = t_1+ ¢(Y - Y)+v
where Y is output, πt is inflation, 0 and Oy capture the responsiveness of
the central bank to inflation and output, a is the sensitivity of output to the
real interest rate and is the sensitivity of inflation to the output gap. Y is
the natural output level, and π* is the central bank's inflation target. [Hint: It
will be helpful to work this question out using diagrams, but you are not
required to provide them as part of your solutions.]
-(πt - π*
π*) +
1+aly
Et
A. (2 points) Explain the impact effect of this shock on output, inflation, and
the real interest rate.
B. (3 points) Explain the dynamic response of output, inflation, and interest
rates in subsequent periods. Does the economy converge back to the
same long-run equilibrium?
C. (2 points) Explain how the central bank responds to inflation and the
importance of the monetary authority following the Taylor principle.
D. (3 points) How would your answer to (B) change if the shock lasted for
several periods (instead of one period) before reverting to zero?](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2Fa09cd305-36cf-4f6b-873f-71c7002cbdfa%2F8f6aee16-3c5c-46c3-90ac-0c4eb2aafef8%2F80gzc8t_processed.png&w=3840&q=75)
Transcribed Image Text:Use a standard dynamic AS-AD model to explain how the macroeconomy
adjusts following a favourable supply shock (vt < 0) for one period which
reverts to zero for all subsequent periods. Assume that the economy starts
from its long-run equilibrium.
As a reminder, the DAD and DAS curves, respectively, are provided below:
Y =Y -
αθη
1+aly
Tt = t_1+ ¢(Y - Y)+v
where Y is output, πt is inflation, 0 and Oy capture the responsiveness of
the central bank to inflation and output, a is the sensitivity of output to the
real interest rate and is the sensitivity of inflation to the output gap. Y is
the natural output level, and π* is the central bank's inflation target. [Hint: It
will be helpful to work this question out using diagrams, but you are not
required to provide them as part of your solutions.]
-(πt - π*
π*) +
1+aly
Et
A. (2 points) Explain the impact effect of this shock on output, inflation, and
the real interest rate.
B. (3 points) Explain the dynamic response of output, inflation, and interest
rates in subsequent periods. Does the economy converge back to the
same long-run equilibrium?
C. (2 points) Explain how the central bank responds to inflation and the
importance of the monetary authority following the Taylor principle.
D. (3 points) How would your answer to (B) change if the shock lasted for
several periods (instead of one period) before reverting to zero?
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