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Describe the action taken by the fed

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Question 

Suppose output is below potential output in year 0. Prices that year are given by P0. In year 1 (with the level of potential output unchanged) the Fed stimulates the economy by shifting the aggregate demand curve until it interest the point (P0, Y*) 

a- A= Sketch the aggregate demand curve for years 0 and 1. Describe the action taken by the Fed 

b- B=Assume that the price adjustment process is given by equation 

Suppose output is below potential output in year 0 


Pi = Pi _1 (- 1) + f ( y_1 - y*/y*) 


If inflation in year 0 was zero, how do prices behave in year 1? Sketch the price adjustment curve for year 1 


c- C=Explain why output in year 1 is above potential 

d- D=In which direction should Fed have shifted the aggregate demand curve to set Y1 =Y*? Is it possible to say? 

e- e=Given the Fed's action, is it possible to say whether prices will increase or decrease in year 2? Why or why not 

 

 

Reference no: EM13745476

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