1. (b)Calculate inflation in periods 1, 2, 3 and 4 if the central bank counteracts the cost- push shock so the output gap is minus 2% in periods 1, 2 and 3 and zero thereafter.

1. (c)Repeat the calculations from part (a), but now assume that the expected inflation rate is constant at 2%. Explain the results.

1. (d)Central bankers are sometimes accused of being obsessed with "credibility". Contrast the results from parts (a) - (c) and explain how these results might shed light on this apparent obsession.

Q4. Oil shocks. The Phillips curve is It , = 1 1_ 1+ BY, +z, Suppose that =1/2, and that in period 0, inflation is 2%. In period 1 there is an unexpected increase in the oil price so Z, =0.03. (a) Calculate inflation in periods 1, 2, 3, 4 and 5 if the output gap is kept at zero all the time. Explain the results