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Monetary Policy: End of Chapter Problem We discussed how hard it is to keep AD stable or put it back "where it belongs" after a shock. Sometimes it is better taking two years to slowly and carefully undo an AD shock rather than shift it back quickly in one year. To illustrate, let's see how things turn out if you take two years rather than one year to react to a negative velocity shock. In this question, your ultimate goal is to get AD back to 5% per year. The potential growth rate is 3% and expected inflation is always 2% per year. Starting point: AD: 1% Inflation + Real Growth Rate SRAS: Inflation Expected Inflation + (Real Growth Rate - Potential Growth Rate) a. Slow approach: Add 2% per year to AD for two years (through some mix of money growth and higher confidence). What will real growth equal each year? Real growth rate at the end of year one: Real growth rate at the start: Real growth rate at the end of year two:

Monetary Policy: End of Chapter Problem We discussed how hard it is to keep AD stable or put it back "where it belongs" after a shock. Sometimes it is better taking two years to slowly and carefully undo an AD shock rather than shift it back quickly in one year. To illustrate, let's see how things turn out if you take two years rather than one year to react to a negative velocity shock. In this question, your ultimate goal is to get AD back to 5% per year. The potential growth rate is 3% and expected inflation is always 2% per year. Starting point: AD: 1% Inflation + Real Growth Rate SRAS: Inflation Expected Inflation + (Real Growth Rate - Potential Growth Rate) a. Slow approach: Add 2% per year to AD for two years (through some mix of money growth and higher confidence). What will real growth equal each year? Real growth rate at the end of year one: Real growth rate at the start: Real growth rate at the end of year two:

ENGR.ECONOMIC ANALYSIS
ENGR.ECONOMIC ANALYSIS
14th Edition
ISBN:9780190931919
Author:NEWNAN
Publisher:NEWNAN
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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of 57 > Monetary Policy: End of Chapter Problem We discussed how hard it is to keep AD stable or put it back "where it belongs" after a shock. Sometimes it is better taking two years to slowly and carefully undo an AD shock rather than shift it back quickly in one year. To illustrate, let's see how things turn out if you take two years rather than one year to react to a negative velocity shock. In this question, your ultimate goal is to get AD back to 5% per year. The potential growth rate is 3% and expected inflation is always 2% per year. Starting point: AD: 1% = Inflation + Real Growth Rate SRAS: Inflation = Expected Inflation + (Real Growth Rate - Potential Growth Rate) a. Slow approach: Add 2% per year to AD for two years (through some mix of money growth and higher confidence). What will real growth equal each year? Real growth rate at the end of year one: % b. Fast approach: Assume you tried to add 4% to AD in Year 1. However, you mistakenly add 7% instead (through some mix of excess bank lending and irrational exuberance). In the second year, you tried to correct by cutting back by 3%, but you mistakenly cut back by 4% (through some mix of slower bank lending and investors' loss of confidence). What will real growth equal each year? Real growth rate at the start: Real growth rate at the end of year two: Real growth rate at the start:
Transcribed Image Text:of 57 > Monetary Policy: End of Chapter Problem We discussed how hard it is to keep AD stable or put it back "where it belongs" after a shock. Sometimes it is better taking two years to slowly and carefully undo an AD shock rather than shift it back quickly in one year. To illustrate, let's see how things turn out if you take two years rather than one year to react to a negative velocity shock. In this question, your ultimate goal is to get AD back to 5% per year. The potential growth rate is 3% and expected inflation is always 2% per year. Starting point: AD: 1% = Inflation + Real Growth Rate SRAS: Inflation = Expected Inflation + (Real Growth Rate - Potential Growth Rate) a. Slow approach: Add 2% per year to AD for two years (through some mix of money growth and higher confidence). What will real growth equal each year? Real growth rate at the end of year one: % b. Fast approach: Assume you tried to add 4% to AD in Year 1. However, you mistakenly add 7% instead (through some mix of excess bank lending and irrational exuberance). In the second year, you tried to correct by cutting back by 3%, but you mistakenly cut back by 4% (through some mix of slower bank lending and investors' loss of confidence). What will real growth equal each year? Real growth rate at the start: Real growth rate at the end of year two: Real growth rate at the start:
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