Problem 1. (Final Exam, Fall 2020) Use the IS-MP-PC framework to answer the following questions. Assume that the economy starts in period 0 in the no-shock long-run equilibrium, in which a=0,R=r=2%,o=0,Y~=0, and =0, with 0=4%. Assume also that the sensitivity coefficient in the Phillips curve is v=0.5 and the sensitivity coefficient in the IS curve is b=2. Be sure to draw the relevant IS-MP-PC diagrams for each of your answers below. 1. Suppose that in period 1 the economy experiences a negative aggregate demand shock a=1 that lasts for one period. Furthermore, in period 2, there is an inflation shock o=1 which also only lasts for one period. Illustrate these events and mark the points at which the economy is located in periods 1 and 2 on both diagrams of the model, if the central banks policy is to maintain the real interest rate constant at the initial level of 2%. What is the rate of inflation in period 2 ? 2. Now assume that the central bank wants to keep the inflation rate constant at 4% using monetary policy. Illustrate this case and mark the point at which the economy is located in periods 1 and 2 on both graphs of the model, given this policy. What are the values of the real interest rate and short-run output in periods 1 and 2 ? Sketch the paths of the real interest rate and short-run output over time in this scenario. 3. Assume that Ct/Yt=a+xY~l, that is, there is a multiplier effect in the IS curve, and x=1/3. Redo part 2 of the problem under this assumption. Make sure to show both the original and the new curves on the models diagrams. Problem 1. (Final Exam, Fall 2020) Use the IS-MP-PC framework to answer the following questions. Assume that the economy starts in period 0 in the no-shock long-run equilibrium, in which a=0,R=r=2%,o=0,Y~=0, and =0, with 0=4%. Assume also that the sensitivity coefficient in the Phillips curve is v=0.5 and the sensitivity coefficient in the IS curve is b=2. Be sure to draw the relevant IS-MP-PC diagrams for each of your answers below. 1. Suppose that in period 1 the economy experiences a negative aggregate demand shock a=1 that lasts for one period. Furthermore, in period 2, there is an inflation shock o=1 which also only lasts for one period. Illustrate these events and mark the points at which the economy is located in periods 1 and 2 on both diagrams of the model, if the central banks policy is to maintain the real interest rate constant at the initial level of 2%. What is the rate of inflation in period 2 ? 2. Now assume that the central bank wants to keep the inflation rate constant at 4% using monetary policy. Illustrate this case and mark the point at which the economy is located in periods 1 and 2 on both graphs of the model, given this policy. What are the values of the real interest rate and short-run output in periods 1 and 2 ? Sketch the paths of the real interest rate and short-run output over time in this scenario. 3. Assume that Ct/Yt=a+xY~l, that is, there is a multiplier effect in the IS curve, and x=1/3. Redo part 2 of the problem under this assumption. Make sure to show both the original and the new curves on the models diagrams