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3. Suppose the Central Bank follows the following policy reaction function ri = base interest rate + 0.5(4-2) +0.5(n – #
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3. Suppose the Central Bank follows the following policy reaction function ri = base interest rate + 0.5(4-2) +0.5(n – #t") where r, denotes the current real interest rate, y denotes current real GDP, Y* denotes potential real GDP, T denotes the current inflation rate and Ti" denotes the target inflation rate. a. What will the effect of an increase in current inflation rate, holding everything else constant, on the aggerate demand? (6 marks) 3 ECC1100 S1 2022 Test Questions b. If the Central Bank follows the following policy reaction function instead, re = base interest rate +0.3 °*") +0.7(ne – ") how will this change the effect discussed in part a above? (4 marks)