Consider the following 3-equation model: Y 108-2rCB +2(G-T) (1) rCB =4+1.5(\pi-\pi)+0.5(Y-Y) (2) \pi \pie+0.5(YY) (3) wherey isoutput, \pi isinflation, \pi e =\pi = 2, andY* = 100. Expected future inflation is \pi e, and Y-Y⚫ is the output gap. The variable rCB is the interest rate set by the central bank. We may interpret \pi as the central bank's inflation target. Government ex- penditure, G, and net taxes, T, are given and set by the government. (a) Which equation is the IS curve, and which is the New Keynesian Phillips curve? Provide a brief economic explanation for the relationship between \pi and \pi e in Equation (3). (b) Find inflation, output and interest rates when G = T = 5. (c) Now suppose G = 8.5 and T = 5. How are inflation, output and interest rates affected? Is the impact of the fiscal expansion on output magnified or reduced by monetary policy? Explain.
Consider the following 3-equation model: Y 108-2rCB +2(G-T) (1) rCB =4+1.5(\pi-\pi)+0.5(Y-Y) (2) \pi \pie+0.5(YY) (3) wherey isoutput, \pi isinflation, \pi e =\pi = 2, andY* = 100. Expected future inflation is \pi e, and Y-Y⚫ is the output gap. The variable rCB is the interest rate set by the central bank. We may interpret \pi as the central bank's inflation target. Government ex- penditure, G, and net taxes, T, are given and set by the government. (a) Which equation is the IS curve, and which is the New Keynesian Phillips curve? Provide a brief economic explanation for the relationship between \pi and \pi e in Equation (3). (b) Find inflation, output and interest rates when G = T = 5. (c) Now suppose G = 8.5 and T = 5. How are inflation, output and interest rates affected? Is the impact of the fiscal expansion on output magnified or reduced by monetary policy? Explain.
Chapter13: Inflation
Section: Chapter Questions
Problem 15SQ
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Transcribed Image Text:Consider the following 3-equation model:
Y 108-2rCB +2(G-T) (1)
rCB =4+1.5(\pi-\pi)+0.5(Y-Y) (2) \pi
\pie+0.5(YY) (3)
wherey isoutput, \pi isinflation, \pi e =\pi = 2, andY* = 100.
Expected future inflation is \pi e, and Y-Y⚫ is the output gap. The variable rCB is the interest rate set by the central
bank. We may interpret \pi as the central bank's inflation target. Government ex- penditure, G, and net taxes, T, are
given and set by the government.
(a) Which equation is the IS curve, and which is the New Keynesian Phillips curve? Provide a brief economic explanation
for the relationship between \pi and \pi e in Equation (3).
(b) Find inflation, output and interest rates when G = T = 5.
(c) Now suppose G = 8.5 and T = 5. How are inflation, output and interest rates affected? Is the impact of the fiscal
expansion on output magnified or reduced by monetary policy? Explain.
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