1 3 Potential output growth and inflationIn this question, we will see how policymakers' beliefs about long run growthcan affect the economy. Remember the two ways of writing the IS curve, andthe Phillips curve:IS curve (output): Y; = (ā+1)Y, – bY :(rt – F)IS curve (output gap): = à – b(rı – F)Phillips curve: T = Tp-1 + vý.You can assume that in period T-1, the output gap and inflation are both zeroand the real interest rate is r; = r.1. Suppose growth in actual output Y, is slowing down. Policymakers believethis is occurring because of a negative shock to aggregate demand (a neg-ative shock to a). Using an IS-MP diagram with the output gap on thehorizontal axis, show how such a shock would account for the slowdown.2. Suppose that policymakers want to make sure the output gap in period Tis 0. Using the same IS-MP diagram, show what monetary policy actionthey will take.

The IS curve shows the negative relationship between interest rate and output. It means as the…

Business

Economics

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Principles of Macroeconomics (MindTap Course List)

7th Edition

ISBN:9781285165912

Author:N. Gregory Mankiw

Publisher:N. Gregory Mankiw

Chapter22: The Short-Run Trade-off Between Inflation And Unemployment

Section: Chapter Questions

Problem 3PA

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