M & B 4th Edition by Dean Croushore

Exercise 16

Consider three alternative policies, each with a different set of outcomes in terms of output and infl ation, as shown in the following table:
Potential output is 500 in period 1 and rises 3 percent per year. The Fed's objective function is

where w = 1, and the infl ation target is 2.0 percent.
a Calculate the value of the objective function over the fi ve-year period for each of the three policies.
b Which policy is best? Why?
c Would your answer to part b change if w = 5? Explain.