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Problem
The above figure depicts the same situation as described in graph, the Fiscal Policy chapter, in the textbook. LRAS = Long Run Aggregate Supply, SRAS = Short Run Aggregate Supply, Real GDP = Real Output , and Yp = full employment output (GDP). The above figure shows an economy that is operating at a current real GDP level of Y1 and a price level of P1.
Answer the following questions:
1- Is this economy experiencing any gap? Explain please.
2- If there is a gap, what kind of monetary policy (tight money policy or easy money policy) is appropriate for the FED to implement? Explain please.
3- Should the FED decide to pursue the appropriate policy, explain the open market operations aspect of such a policy.
4- How would this policy affect the Aggregate Demand (AD) curve? Explain please.
Why might it be difficult for the Fed to formally adopt inflation targeting? Would inflation targeting be a good policy for the Fed in the present economic environment
In using the Taylor Rule as a guideline for monetary policy, what are the pros and cons of using forecasted values of inflation and output rather than observed values of these variables?
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