The Effects of an Increase in the Price of Oil. Consider an economy whose IS curve is such that

Y = C (Y ? T) + I (Y,r + x, p_o) + G

where p_o stands for the price of oil. Suppose that an increase of p_o will reduce the amount of investment and on the other hand increase the mark-up m of the economy. Further assume that ?^e_t = ?t?1. Finally, assume that the current interest rate is such that r = r_n.

(a) Suppose the central bank aims to maintain a stable inflation. Discuss the impacts of a permanent increase in p_o on output and inflation both in the short run and in the medium run.

(b) Suppose the central bank aims to maintain a constant inflation instead. Discuss the impacts of a permanent increase in p_o on output and inflation both in the short run and in the medium run.

(Hints: Maintaining a constant inflation means the CB wants to keep inflation at its original level for example 2%. Maintaining a stable inflation means the CB does not care about the level of inflation. He only cares about whether or not it is changing.)

(c) Are there any difference to your answers in part (a) and (b) if the expectation formation is such that ?_t^e = ?.

Please be subject to the picture

6. The Effects of an Increase in the Price of Oil. Consider an economy whose IS curve is such that Y = C(Y - T) + I(Y,r+ x, Po) + G where po stands for the price of oil. Suppose that an increase of po will reduce the amount of investment and on the other hand increase the mark-up m of the econ- omy. Further assume that if = 7-1. Finally, assume that the current interest rate is such that r = In. (a) Suppose the central bank aims to maintain a stable inflation. Discuss the impacts of a permanent increase in po on output and inflation both in the short run and in the medium run. (b) Suppose the central bank aims to maintain a constant inflation instead. Dis- cuss the impacts of a permanent increase in po on output and inflation both in the short run and in the medium run. (Hints: Maintaining a constant inflation means the CB wants to keep in- flation at its original level for example 2%. Maintaining a stable inflation means the CB does not care about the level of inflation. He only cares about whether or not it is changing.) (c) Are there any difference to your answers in part (a) and (b) if the expectation formation is such that n; = 7