Plicy choice for real interest rate changes your policy

Reference no: EM13454466

Assume an economy with an AE curve with a slope of 1 where a one percent change in real interest rates changes real GDP by 1 percent with a one year lag. This economy is also characterized by an ouput gap Phillips curve where a one percentage point change in the output gap affects inflation with a one year lag. From Okun's law for this economy a 1 percent change in real GDP changes the unemployment rate by .5%. The natural rate of unemployment for this economy is 5%. The neutral real rate of interest rⁿ= 3.0 %/ and the target rate of inflation Π^T = 2%.

Assumes that policy makers inherit an economy at its natural rate of unemployment (5%), 6 percent inflation in year 0, and decide to use an aggressive Taylor rule of:

r = 3% + 1.0 (Y-Y*/Y*) + 1.0 (Π - 2%)

Fill in the following table assuming that policy makers have a correct model of the economy, follow the aggressive Taylor rule, and the economy has the two one period lags. Remember that in each year the policy choice for the real interest rate changes. (Your policy choice in year 0 affects GDP in Y in year 1 and how that policy affects GDP in year 1 affects inflation in year 2.

Hint. Use the Taylor rule to pick r in period 0 based on information in table. That r chosen for year 0 will have an impact on Y (and u based on Okun's law) in year 1, but will have no impact on inflation until year 2 depending on the output gap that opens up in year 1.



Year	r	Π	Y	(Y-Y/Y	Π-Π^T	u	i
	(policy)			ouptut gap			nominal
							interest rate


0		6.0	100.0	0	4.0	5.0

1

2

3

4

Reference no: EM13454466

Questions Cloud

When colonizing the new world the techniques both natives : when colonizing the new world the techniques both natives and europeans employed in warfare was affected by the

Explain the basic structure including molecular composition : all living cells both prokaryotic and eukaryotic have the following cell structures plasma membrane cytosol ribosomes

Use the powerpoint template under the assignment area or : use the powerpoint template under the assignment area or you may create your own powerpoint to discuss the

In this description board you will look at the structure of : when you look at the world around us you can see many examples that demonstrate how an objects or a systems structure

Plicy choice for real interest rate changes your policy : assume an economy with an ae curve with a slope of 1 where a one percent change in real interest rates changes real gdp

What experience or knowledge do you have of any : what experience or knowledge do you have of any contemporary segregation happening in your local schools a school you

Supposing that the companys 71000 ending goods in process : hemingway inc. applies factory overhead based on direct labor costs. the company incurred the following costs during

What makes up the plasma membrane list and describe the : q1. discuss the qualities of water that make it unique and why hydrogen bonds are responsible.q2. what are the

Analyzing art and literature in the northern renaissance : analyzing art and literature in the northern renaissance please respond to the following using sources under the

User Account

All Pages