Question 3:

(a) What do you understand by the concept of "Time Inconsistency" in the context of monetary policy? Give an (economic) example. What does Time Inconsistency imply about whether monetary policy should follow rules or be discretionary?

(b) What role does credibility play in the effectiveness of monetary policy - illustrate your answer using the AD/AS model in the face of a negative aggregate shock that raises production cost.

(4 marks)

(c) What is the Taylor Rule? What does it imply about how monetary policy should operate?