Suppose in Friedman-Lucas money surprise model, there is a negative TFP shock. Neither private sector agents nor the central bank can observe this shock directly. The central bank is committed to interest rate targeting.

a- Using labour market diagram, draw the impact of this shock on the labour demand holding the interest rate constant. Provide an explanation

b- Argue that what happened in part (a) will affect the goods market.

c- What action the central bank will take? How will this intervention affect the labour

supply and goods market? You do not need to draw any diagram

d- Draw diagrams (labour market, goods market, and money market) to illustrate the final

stage of the economy after the shock.