Question 7: Monetary Policy: Suppose that the economy is described as follows. Consumption function is given by C = 2500 - 40TT, where i denotes the inflation rate. Investment is given by I = 1000 - 100r, where r denotes the real interest rate. Government spending (G) is given by 1200. Exports (X) is equal to 400 and imports (M) is 500. Assume now that the Central Bank (RBA) decides to reconsider the interest rate rule and now sets the nominal interest rate as follows: i() = 0.03 + 1.3m a. Find the new RBA (Central Bank policy reaction function for the real interest rate r. b. Write down the new equation for the AD curve of this economy in terms of T. c. Will the new AD curve (steeper or flatter)? How would you describe the change in AD as a consequence of the change in the interest rate rule? d. Is the Central Bank conducting passive or active monetary policy when it changes its interest rate rule? Explain. Answer: Answer 7a) The RBA Policy function real interest rate:= Answer 7b) New AD = Answer 7c) The new AD curve will be flatter / steeper and will shift to the left / right. Answer 7d) Active / Passive policy