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ECON311: Macroeconomic Policy- Report Writing Assignment
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Internal Code: MAS1820
(b) Assuming that in period 1 the economy is hit by the demand shock ?a=-3 lasting for one period, find the values of inflation, short?run output and the real interest rate in periods 1 and 2. Explain how the economy will adjust to its long?run equilibrium starting from period 3. Accompany your answer with a graph.
(c) Now assume that in addition to the demand shock from (b), in period 1 the economy is also hit by the supply shock o=-3 lasting for 1 period. Find the values of inflation, short? run output and the real interest rate in periods 1 and 2. Explain how the economy will adjust to its long?run equilibrium starting from period 3. Accompany you answer with a graph.
(d) Briefly explain how would your answer to (b) and (c) would change qualitatively if ? ?were higher.
Question 2:
Assume that the central bank follows the following simplified version of the Taylor rule:
(a) First, assume that the risk premium p= 0. Draw an IS?MP diagram but instead of the usual MP curve, graph the monetary policy rule. You might label this curve MPT for the simplified Taylor rule.
(b) Now consider the effect of an increase in risk premium from 0 to some positive value in the IS?MPT diagram. Compare and contrast the effect of this risk premium shock on the economy in the standard IS?MP diagram (without policy response to the shock) versus the IS?MPT diagram. Is there a difference?
(c) If the central bank follows the simplified Taylor rule, how would the AD curve look like? Explain. Now show the effect of the risk premium shock on the AS/AD diagram in the period when the shock hits. Is this consistent with what you had in the IS?MPT diagram?
Report Writing Assignment:
Task: Assume that the central bank can directly observe the aggregate demand shock and follows the following monetary policy rule:
(b) Assuming that in period 1 the economy is hit by the demand shock ?a=-3 lasting for one period, find the values of inflation, short?run output and the real interest rate in periods 1 and 2. Explain how the economy will adjust to its long?run equilibrium starting from period 3. Accompany your answer with a graph.
(c) Now assume that in addition to the demand shock from (b), in period 1 the economy is also hit by the supply shock o=-3 lasting for 1 period. Find the values of inflation, short? run output and the real interest rate in periods 1 and 2. Explain how the economy will adjust to its long?run equilibrium starting from period 3. Accompany you answer with a graph.
(d) Briefly explain how would your answer to (b) and (c) would change qualitatively if ? ?were higher.
Question 2:
Assume that the central bank follows the following simplified version of the Taylor rule:
(a) First, assume that the risk premium p= 0. Draw an IS?MP diagram but instead of the usual MP curve, graph the monetary policy rule. You might label this curve MPT for the simplified Taylor rule.
(b) Now consider the effect of an increase in risk premium from 0 to some positive value in the IS?MPT diagram. Compare and contrast the effect of this risk premium shock on the economy in the standard IS?MP diagram (without policy response to the shock) versus the IS?MPT diagram. Is there a difference?
(c) If the central bank follows the simplified Taylor rule, how would the AD curve look like? Explain. Now show the effect of the risk premium shock on the AS/AD diagram in the period when the shock hits. Is this consistent with what you had in the IS?MPT diagram?