Exam 15: A Dynamic Model of Economic Fluctuations

Central Bank A conducts monetary policy according to the following monetary policy rule: i = $\pi$ + 2.0 + 0.90 ( $\pi$ - 2.0) + 0.10 (Y - 100), and Central Bank B conducts monetary according to the following monetary policy rule: i = $\pi$ + 2.0 + 0.10 ( $\pi$ - 2.0) +0 .90 (Y - 100), where i is the nominal interest rate measured in percent, $\pi$ is the inflation rate measured in percent, and Y is output measured as a percentage of the natural level of output. The economies of the two countries are otherwise identical and operate as described by the dynamic model of aggregate demand and aggregate supply. a. In which country will the dynamic aggregate demand curve be steeper? Explain. b. If a positive supply shock of the same magnitude hits both countries, which country will experience the greatest variability in output? Explain.

The negative relationship between inflation and the quantity of goods and services demanded comes about because of the:

Starting from long-run equilibrium in the dynamic model of aggregate demand and aggregate supply, output immediately decreases as a result of a one-period positive supply shock because:

According to the monetary policy rule (assuming $\theta$ _$\pi$ > 0) when inflation increases, the central bank increases the nominal interest rate by _____ the increase in the rate of inflation, which _____ the real interest rate.

According to the Phillips curve, inflation depends on expected inflation because:

Use the model of dynamic aggregate demand and aggregate supply to graphically illustrate the impact of a temporary 4-period increase in taxes (a four-period negative demand shock) on output and inflation when the economy is initially at long-run equilibrium. Explain the time path of output and inflation in words.

The real interest rate at which, in the absence of any shock, the demand for goods and services equals the natural rate of output is called the _____ rate of interest.

Beginning at long-run equilibrium in the dynamic model of aggregate demand and aggregate supply, in the first period of a four-period positive demand shock, the DAS curve _____ and the DAD curve _____.

That output, Y_t, and the real interest rate, r_t, do not depend on the central bank's inflation target in long-run equilibrium in the dynamic model of aggregate demand and aggregate supply demonstrates:

According to the monetary policy rule, under what condition does the real interest rate equal the natural rate of interest? What does the Taylor principle suggest for a monetary policy design?

The natural rate of interest is the real interest rate:

Beginning at long-run equilibrium in the dynamic model of aggregate demand and aggregate supply, in the periods after a multiperiod positive demand shock occurs, the DAS shifts upward because:

The dynamic aggregate demand curve illustrates the _____ relationship between the quantity of output demanded in the short run and _____.

The dynamic aggregate demand curve is derived from each of the following equations of the model of aggregate demand and aggregate supply except:

In the dynamic model of aggregate demand and aggregate supply, one period in time is connected to the next period through:

Illustrate with a graphs the dynamic aggregate demand curve (DAD) and dynamic aggregate supply curve (DAS).

Which of the following is an exogenous variable in the dynamic model of aggregate demand and aggregate supply?

In the specification of adaptive expectation used in the dynamic model of aggregate demand and aggregate supply, at time t the expected inflation rate at time t + 1 is:

John Taylor's rule for setting the federal funds rate proposes increasing the nominal federal funds rate as inflation _____ and the GDP gap _____.

The Taylor rule can be written as FF rate = $\pi$ + 2.0 + 0.5 ( $\pi$ - 2.0) + 0.5(GDP gap), where FF rate is the nominal federal funds rate, $\pi$ is the inflation rate, and the GDP gap is the percentage deviation of real GDP from its natural level. If inflation is 2 percent and GDP is at the natural rate, then according to the Taylor rule, the Fed should set the nominal federal funds rate at _____ percent.