i. Use the Taylor rule to determine the appropriate setting of the overnight interest rate if the
Question:
i. Use the Taylor rule to determine the appropriate setting of the overnight interest rate if the current inflation is 1%, equilibrium overnight interest rate is 2%, target inflation is 2% and there is a recessionary output gap of 2%.
ii. Now assume the Taylor Rules gives a weight of to Inflationary gap thereby mandating a hierarchal goal of price stability (weight of output gap would be now). Using the Taylor rule determine the appropriate setting of the overnight interest rate if the current inflation is 1%, equilibrium overnight interest rate is 2%, target inflation is 2% and there is a recessionary output gap of 2%.
iii. Using the standard Taylor rule with coefficient of inflation gap at 0.5, explain how should Bank of Canada change the target for overnight interest rate if economy sees potential real GDP growing at a pace slower than the current GDP.
2. Compare Reserve aggregate and short term interest rate as choices for a policy instrument. What criterion is used to select a good policy instrument? 3. (3x 4= 12 points) Using the AD-AS model, show and describe the effects in the short run and long run if:
i. COVID-19 forces households to self-quarantine and causes a huge decrease in consumption spending
ii. Financial frictions (problems of adverse selection and moral hazard) decrease
iii. A permanent negative supply shock - example endemic corruption
iv. Negative temporary supply shock accompanied by a decline in Investment by firms
For all parts draw diagrams to explain your answers and assume economy was initially at long run equilibrium. Must detail the effect on inflation, GDP (Y) and Unemployment both in the short run and the Long run to get full credit. Econ2210-R10-Assignment4- Spring 2020
4. (6 points) Using the AD-AS model in chapter 23 explain the difference between cost-push inflation and demand pull inflation. Draw diagrams to help explain your answer.
5. (4x3 = 12 points) For each of the following shocks to the economy explain and illustrate the effect of Activist Monetary Policy that has a hierarchal goal of price stability (inflation targeting):
i. COVID-19 forces households to self-quarantine and causes a huge decrease in consumption spending
ii. Strong labour unions drive up nominal wages
iii. Firms increase their investment spending expecting higher GDP growth rate in the future For each case assume that inflation was at it's target level and GDP (Y) was at it's potential level before the shock.
6. (4 point) Explain the shape of the kinked Demand curve that has an upward sloping segment for very low inflation rates in chapter 24 (page 622).
7. (3x3 = 9 points) What are the three different non conventional monetary policies that can be used at the zero lower bound. Which curve on your AD-AS diagram be affected by each. Explain briefly.