Question 2. AD-AS Analysis with an Alternative Policy Rule. This questionwill have you derive a version of the aggregate demand curve under alternativeassumptions about how the Fed conducts policy.Assume that the IS curve assumes the usual form:Y =С − mpc × T +Ī+Ğ1 - mpc1d.mpcXP,where Y is output, ris the real interest rate, and the remaining parameters utilizethe same notion that we used in class. Suppose that the Fed's actions are summarizedby the following monetary policy curve:r=r+ax (Y−YP) + X XT, where YP is potential output, π is the inflation rate, and is the autonomouscomponent of monetary policy. Assume that the short-run aggergate supply curveassumes the usual form:π = π² + y(Y - Yº) + p,where is expected inflation, and p is an inflationary shock.a) Why would the output gap enter into the Fed's moetary policy rule?Would you expect a to be positive or negative, why? How would you interpreta and λ?b) Combine the IS curve and the monetary policy curve to obtain anaggregate demand curve. That is, express output Y as a function of inflationT. (This expression will also contain the exogenous quantities C, I, G,T,and T as well as potential output Yº and the parameters mpc, d, a and""lambda .)c) How does a affect the sensitivity of Y to changes in π ? If πincreases by one, then by how much does Y change?d) Suppose that the aggregate demand curve and the aggregate supplycurve intersect at a value of Y that's greater than Yº. What curve (orcurves) shift to return the economy to a long-run equilibrium, and why? Drawa graph of aggregate demand and aggregate supply to show how the economyadjusts. What happens to inflation and output?

The output gap would enter the fed's monetary policy because along with inflation targeting and…

Question 2. AD-AS Analysis with an Alternative Policy Rule. This question will have you derive a version of the aggregate demand curve under alternative assumptions about how the Fed conducts policy. Assume that the IS curve assumes the usual form: Y = C-mpc x T +Ī+Ģ 1 mpc 1 d mpc xr, where Y is output, r is the real interest rate, and the remaining parameters utilize the same notion that we used in class. Suppose that the Fed's actions are summarized by the following monetary policy curve: r=r+ax (Y – YP) + λ × π,

Question 2. AD-AS Analysis with an Alternative Policy Rule. This question will have you derive a version of the aggregate demand curve under alternative assumptions about how the Fed conducts policy. Assume that the IS curve assumes the usual form: Y = C-mpc x T +Ī+Ģ 1 mpc 1 d mpc xr, where Y is output, r is the real interest rate, and the remaining parameters utilize the same notion that we used in class. Suppose that the Fed's actions are summarized by the following monetary policy curve: r=r+ax (Y – YP) + λ × π,

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Question

where YP is potential output, π is the inflation rate, and is the autonomous
component of monetary policy. Assume that the short-run aggergate supply curve
assumes the usual form:
π = π² + y(Y - Yº) + p,
where is expected inflation, and p is an inflationary shock.
a) Why would the output gap enter into the Fed's moetary policy rule?
Would you expect a to be positive or negative, why? How would you interpret
a and λ?
b) Combine the IS curve and the monetary policy curve to obtain an
aggregate demand curve. That is, express output Y as a function of inflation
T. (This expression will also contain the exogenous quantities C, I, G,T,
and T as well as potential output Yº and the parameters mpc, d, a and
"
"
lambda .)
c) How does a affect the sensitivity of Y to changes in π ? If π
increases by one, then by how much does Y change?
d) Suppose that the aggregate demand curve and the aggregate supply
curve intersect at a value of Y that's greater than Yº. What curve (or
curves) shift to return the economy to a long-run equilibrium, and why? Draw
a graph of aggregate demand and aggregate supply to show how the economy
adjusts. What happens to inflation and output?

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