Question 3 Consider the 3-equation model (without a banking sector) with adaptive expectations for inflation. Suppose th
Posted: Thu May 19, 2022 7:29 am
Question 3 Consider the 3-equation model (without a banking
sector) with adaptive expectations for inflation. Suppose that the
economy is hit by a permanent positive aggregate supply shock.
a) Use a diagram to explain the adjustment of the economy to its
new equilibrium (diagram must be hand-drawn, describe very briefly
in words the sequence of events). (10 marks)
b) Draw the impulse response functions for output, inflation and
the interest rate (IRFs must be hand drawn). (10 marks)
c) Suppose now that agents have rational expectations (instead
of adaptive expectations). Would the new equilibrium levels of
output, inflation and interest rate be different from above? What
would be different? (You do not need to describe the adjustment
process. You can provide an intuitive answer without using graphs
or maths) (5 marks) [Total: 25 marks]
sector) with adaptive expectations for inflation. Suppose that the
economy is hit by a permanent positive aggregate supply shock.
a) Use a diagram to explain the adjustment of the economy to its
new equilibrium (diagram must be hand-drawn, describe very briefly
in words the sequence of events). (10 marks)
b) Draw the impulse response functions for output, inflation and
the interest rate (IRFs must be hand drawn). (10 marks)
c) Suppose now that agents have rational expectations (instead
of adaptive expectations). Would the new equilibrium levels of
output, inflation and interest rate be different from above? What
would be different? (You do not need to describe the adjustment
process. You can provide an intuitive answer without using graphs
or maths) (5 marks) [Total: 25 marks]