Explain the impact effect of this shock on output, inflation, and the real interest rate.Explain the dynamic response of output, inflation, and interest rates in subsequent periods. Does the economy converge back to the same long-run equilibrium?Explain how the central bank responds to inflation and the importance of the monetary authority following the Taylor principle.How would your answer to (B) change if the shock lasted for several periods (instead of one period) before reverting to zero? Dynamic AS-AD ModelUse a standard dynamic AS-AD model to explain how the macroeconomy adjusts following afavourable supply shock (vt < 0) for one period which reverts to zero for all subsequent periods.Assume that the economy starts from its long-run equilibrium.As a reminder, the DAD and DAS curves, respectively, are provided below:Y =Y -ап1+αθηTt = Tt_1+ ¢(Y - Y) + vtwhere Yt is output, π is inflation,and Oy capture the responsiveness of the central bank toinflation and output, a is the sensitivity of output to the real interest rate and is the sensitivity ofinflation to the output gap. Y is the natural output level, and * is the central bank's inflationtarget. [Hint: It will be helpful to work this question out using diagrams, but you are not required toprovide them as part of your solutions.]・(πt- π*) +1+aly•Et

Aggregate demand is the total demand for goods and services in an economy at a given period of time.…

Answered: Use a standard dynamic AS-AD model to…

Macroeconomics: Private and Public Choice (MindTap Course List)

16th Edition

ISBN:9781305506756

Author:James D. Gwartney, Richard L. Stroup, Russell S. Sobel, David A. Macpherson

Publisher:James D. Gwartney, Richard L. Stroup, Russell S. Sobel, David A. Macpherson

Chapter10: Dynamic Change, Economic Fluctuations, And The Ad-as Model

Section: Chapter Questions

Problem 8CQ

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Explain the impact effect of this shock on output, inflation, and the real interest rate.

Explain the dynamic response of output, inflation, and interest rates in subsequent periods. Does the economy converge back to the same long-run equilibrium?

Explain how the central bank responds to inflation and the importance of the monetary authority following the Taylor principle.

How would your answer to (B) change if the shock lasted for several periods (instead of one period) before reverting to zero?

Dynamic AS-AD Model
Use a standard dynamic AS-AD model to explain how the macroeconomy adjusts following a
favourable supply shock (vt < 0) for one period which reverts to zero for all subsequent periods.
Assume that the economy starts from its long-run equilibrium.
As a reminder, the DAD and DAS curves, respectively, are provided below:
Y =Y -
ап
1+αθη
Tt = Tt_1+ ¢(Y - Y) + vt
where Yt is output, π is inflation,
and Oy capture the responsiveness of the central bank to
inflation and output, a is the sensitivity of output to the real interest rate and is the sensitivity of
inflation to the output gap. Y is the natural output level, and * is the central bank's inflation
target. [Hint: It will be helpful to work this question out using diagrams, but you are not required to
provide them as part of your solutions.]
・(πt
- π*) +
1+aly
•Et

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