3. Answer all parts of this question. (a) Suppose that the central bank is at its bliss point where inflation is at its target and there is no output gap. Suppose that the government writes a new law that imposes a higher inflation target for the central bank and this affects anticipated inflation. However, the law will not take effect for two years. In the meantime, the central bank pursues its current goals, as specified by its loss function, given the current inflation target. Determine the effect of the news that the law has passed on the central bank’s current policy, and on aggregate output and inflation. Use diagrams to explain your results. (b) Assume a two-period small open economy model where national income is 150 in the current period and 140 in the future period. The world real interest rate is assumed to be 4% per period. The representative consumer always wishes to set current consumption plus government spending equal to future consumption plus government spending, (C+G=C′+G′), which implies perfect complements preferences. (i) Determine equilibrium consumption plus government spending in the current and future periods, and also the current account surplus. Draw a large diagram to illustrate your results. Put in the actual number for the X and Y axis intercepts of the national intertemporal budget constraint. (ii) Now, suppose that the world real interest rate decreases to 2% per period. Again, determine consumption plus government spending in the current and future periods and also the current account surplus, and show these in the same diagram. Put in the actual number for the X and Y axis intercepts of the national intertemporal budget constraint. (iii) Instead suppose that the world real interest rate is 4% per period and national income increases to 160 in the future period. Again, determine consumption plus government spending in the current and future periods and also the current account surplus, and show these in the same diagram. Put in the actual number for the X and Y axis intercepts of the national intertemporal budget constraint. (iv) Instead suppose that the world real interest rate decreases to 2% per period and national income increases to 160 in the future period. Again, determine consumption plus government spending in the current and future periods and also the current account surplus, and show these in the same diagram. Put in the actual number for the X and Y axis intercepts of the national intertemporal budget constraint. (v) Explain the difference in your results in parts (i)-(iv).
3. Answer all parts of this question.
(a) Suppose that the central bank is at its bliss point where inflation is at its target and there
is no output gap. Suppose that the government writes a new law that imposes a higher
inflation target for the central bank and this affects anticipated inflation. However, the
law will not take effect for two years. In the meantime, the central bank pursues its
current goals, as specified by its loss function, given the current inflation target.
Determine the effect of the news that the law has passed on the central bank’s current
policy, and on
(b) Assume a two-period small open economy model where
current period and 140 in the future period. The world real interest rate is assumed to be
4% per period. The representative consumer always wishes to set current consumption
plus government spending equal to future consumption plus government
spending, (C+G=C′+G′), which implies perfect complements preferences.
(i) Determine equilibrium consumption plus government spending in the current and
future periods, and also the current account surplus. Draw a large diagram to
illustrate your results. Put in the actual number for the X and Y axis intercepts of
the national intertemporal budget constraint.
(ii) Now, suppose that the world real interest rate decreases to 2% per period. Again,
determine consumption plus government spending in the current and future
periods and also the current account surplus, and show these in the same diagram.
Put in the actual number for the X and Y axis intercepts of the national
intertemporal budget constraint.
(iii) Instead suppose that the world real interest rate is 4% per period and national
income increases to 160 in the future period. Again, determine consumption plus
government spending in the current and future periods and also the current
account surplus, and show these in the same diagram. Put in the actual number
for the X and Y axis intercepts of the national intertemporal budget constraint.
(iv) Instead suppose that the world real interest rate decreases to 2% per period and
national income increases to 160 in the future period. Again, determine
consumption plus government spending in the current and future periods and also
the current account surplus, and show these in the same diagram. Put in the actual
number for the X and Y axis intercepts of the national intertemporal budget
constraint.
(v) Explain the difference in your results in parts (i)-(iv).
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