Consider an economy where aggregate supply is given by the Lucas supply curve: y= (-), where...
Fantastic news! We've Found the answer you've been seeking!
Question:
Transcribed Image Text:
Consider an economy where aggregate supply is given by the Lucas supply curve: y= (-), where is actual inflation rate, and Te is private sector's expectation on inflation. Let yn denotes the socially optimal level of output, and inflation above some level, *, is costly. The central bank's objective function is characterized by U=A (y-yn) - (*), A> O (1) Finally, the policy maker controls money growth rate, and thus . (a) (3 points) Show the First-Best monetary policy (Pareto optimal allocation). (b) (3 points) What is equilibrium policy with commitment? Does it achieve the First-Best allocation? Explain. (c) (3 points) Show that the policy maker always has incentive to deviate from the allocation in (b), if there exists commitment issue. (d) (4 points) Solve the equilibrium policy under discretion and show that policy under dis- cretion is inferior to that under commitment. Now consider the environment with real shocks. The Lucus supply curve now changes to: - y=yna (TT) +, a > 0, where is an output shock (E (E) = 0, var (e) = 2). We assume that the output shock is observed by central bank but not by the public. The monetary-policy instrument is denoted by z and thus the inflation rate is affect by policy instrument as follows: T=2+V, where v is a shock not observed by the central bank and E (v) = 0, var (v) = 2. i.e., z controls imperfectly. The central bank's objective function is expeted version of (1), i.e. U = X(-n) - (*), - where is the target rate of inflation (note that NO expectation on terms of U, but central bank maximize E[U]), and A> 0. Now consider the case where the central bank chooses z using discretion rather than a rule. (e) (4 points) Show that the optimal setting of zis: * = a +". (f) (4 points) What is the equilibrium inflation? Show the inflation bias exists. Discuss briefly. (g) (4 points) What is y and E[U] in equilibrium. Does the extra inflation generate additional output or improve expected utility? If not, any explanation for the extra inflation? Consider an economy where aggregate supply is given by the Lucas supply curve: y= (-), where is actual inflation rate, and Te is private sector's expectation on inflation. Let yn denotes the socially optimal level of output, and inflation above some level, *, is costly. The central bank's objective function is characterized by U=A (y-yn) - (*), A> O (1) Finally, the policy maker controls money growth rate, and thus . (a) (3 points) Show the First-Best monetary policy (Pareto optimal allocation). (b) (3 points) What is equilibrium policy with commitment? Does it achieve the First-Best allocation? Explain. (c) (3 points) Show that the policy maker always has incentive to deviate from the allocation in (b), if there exists commitment issue. (d) (4 points) Solve the equilibrium policy under discretion and show that policy under dis- cretion is inferior to that under commitment. Now consider the environment with real shocks. The Lucus supply curve now changes to: - y=yna (TT) +, a > 0, where is an output shock (E (E) = 0, var (e) = 2). We assume that the output shock is observed by central bank but not by the public. The monetary-policy instrument is denoted by z and thus the inflation rate is affect by policy instrument as follows: T=2+V, where v is a shock not observed by the central bank and E (v) = 0, var (v) = 2. i.e., z controls imperfectly. The central bank's objective function is expeted version of (1), i.e. U = X(-n) - (*), - where is the target rate of inflation (note that NO expectation on terms of U, but central bank maximize E[U]), and A> 0. Now consider the case where the central bank chooses z using discretion rather than a rule. (e) (4 points) Show that the optimal setting of zis: * = a +". (f) (4 points) What is the equilibrium inflation? Show the inflation bias exists. Discuss briefly. (g) (4 points) What is y and E[U] in equilibrium. Does the extra inflation generate additional output or improve expected utility? If not, any explanation for the extra inflation?
Expert Answer:
Answer rating: 100% (QA)
e To find the optimal setting of z when the central bank chooses discretion rather than a rule we ne... View the full answer
Related Book For
Posted Date:
Students also viewed these finance questions
-
ways come statements for the last two Problem #5-(10 marks) Chapparal Co. is a merchandising company that buys and resells tires for rally race cars. The company's income statements for the last two...
-
This question concerns lexical grammars. (a) Tree Adjoining Grammars contain two types of elementary tree. (i) What are these trees called? [1 mark] (ii) If one were building a grammar for English...
-
123 Compare the purely graphical properties of these two notations, and the ways in which the graphical properties of each display correspond to the information structure being defined. Describe...
-
You work as a manager in the admission department of company. You were asked by your department head to present and analyze the qualifying test scores of 40 employees who are applying for 5-year...
-
A student makes a trip once per day to the store, and he always buys a snack. The student eats the snack 70% of the time, but the other 30% of the time, his roommate eats it first. a. During a period...
-
Jim Andrews opened a delivery business in March. He rented a small office and has a part-time assistant. His trial balance shows accounts for the first three months of business. Andrews' transactions...
-
U-Save Automotive Group purchased 10 vehicles during the current month. Two trucks were purchased for \(\$ 20,000\) each, two SUVs were purchased for \(\$ 31,000\) each, and six hybrid cars were...
-
1. What problems did IGT face before the implementation of the ERP system? 2. How does the new system help control processes? 3. Compared to the situation in 2002, what are the benefits of the ERP...
-
What is the slope of the tangent line to the curve (You should then solve for dx/dy) y^2 2xyy 5sec^2(xy)(y xy)2y 1 = 0 at the point (4,0). A) 0.5 B) -0.0556 C) 0.8667 D) Undefined E) -0.8667
-
+Vcc 14 R Re G The power amplifier shown is used to drive an 802/32W speaker through the transformer whose turn ratio is 2:1. The supply voltage is 24 volts. Current gain (B) of the transistor is 50....
-
Give an example of an experience that you have had with a company that uses a CRM system?
-
what ways do contemporary political leaders employ Machiavellian principles to consolidate and maintain power, and what are the ethical ramifications ?
-
Solo Company Limited, located in Mexico City, is a wholly owned subsidiary of Partner Incorporated, a U.S. company. At the beginning of the year, Solo's condensed balance sheet was reported in...
-
(a) Bioman Corporation produces chemical products. The following data are from the company's Mixing Department: Work in Process, beg. 800,000 Stage of Completion 30% Units started in Process 700,000...
-
Shirley's Sandwiches expects earnings per share of this year (at t=1) of $15.03. The company has a large number of good projects and plans to reinvest all earnings with a return on new investment of...
-
fill in the stars. Foxy Inc.'s financial statement and taxable income for Year 1 follows (income before the effect of tax-related differences was $140,000): FINANCIAL STATEMENT PRE-TAX INCOME $...
-
Name some of the various types of financial intermediaries described in the chapter and indicate the primary reason(s) each was created.
-
Teague Corporation has the following long-term investments: 1. 60 percent of the common stock of Ariel Corporation 2. 13 percent of the common stock of Copper, Inc. 3. 50 percent of the nonvoting...
-
The stockholders equity section of Caritas Corporations balance sheet appeared as follows on December 31: Swanson Manufacturing Company owns 80 percent of Caritass voting stock and paid $11.20 per...
-
Edson Manufacturing Company purchased 100 percent of the common stock of Liverpool Manufacturing Company for $600,000. Liverpools stockholders equity included common stock of $400,000 and retained...
Study smarter with the SolutionInn App