I need help answering this chapter 9 question 3 from Macroeconomics by Olivier B

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I need help answering this chapter 9 question 3 from Macroeconomics by Olivier Blanchard. Thank you

oo Verizon 7:30 AM chegg.com The two paths to the medium-run equilibriun explored in this chapter make two different assumptions about the formation of the level of expected inflation. One path assumes the level of expecteed inflation equals lagged inflation. The level of expected inflation changes over time. The other path assumes the level of expected inflation is anchored to a specific value and never changes. Begin in medium-run equilibrium where actual and expected inflation equals 2% in period t a. Suppose there is an increase in consumer confidence in pe- riod t 1. How does the IS curve shift? Assume that the central bank does not change the real policy rate. How will the short-run equilibrium in period t + 1 compare to the equilibrium in period t? b. Consider the period t 2 equilibrium under the assump- tion that 1+2-+1. If the central bank leaves the real policy rate unchanged, how does actual inflation in period t 2 compare to inflation in period t+1? How must the central bank change the nominal policy rate to keep the real policy rate unchanged? Continue to periodt + 3 Making the same assumption about the level of expected inflation and the real policy rate, how does actual inflation in period t + 3 compare to inflation in period t +2 c. Consider the period t 2 equilibrium making the as- sumption that 1+ 2-T. If the central bank leaves the real policy rate unchanged, how does actual inflation in period t + 2 compare to inflation in period t + 1? How must the central bank change the nominal policy rate to keep the real policy rate unchanged? Continue to period t 3. Making the same assumption about the level of expected inflation and the real policy rate, how does actual inflation in period t+3 compare to inflation in period t 2? d. Compare the inflation and output outcomes in part b to e. Which scenario, part b or part c, do you think is more real- f. Suppose in period t + 4, the central bank decides to raise that in part c. istic. Discuss the real policy rate high enough to return the economy immediately to potential output and to the period t rate of inflation. Explain the difference between central bank poli- cies using the two assumptions about expected inflation in part b and part c.

Explanation / Answer

The two paths of the medium run equiliobrim explores twoo different assumptions about the formation of the level of expected inflation. One path assumes the level of expected inflation equals the lagged inflation. The other path assumes the level of expected inflation is anchored to the specific value and never changes.

thge actual and expected inflation at period t= 2% in midium run equilibrium.

a. It is supposed that there is an increase in consumer confidence in period t+1. Generally an increase in consumer's confidence shifts the aggregate demand curve to the right, this means AD increases. So as a result the IS will increase due to increase in the quantity demanded. IS curve will shift to the right. Assumimg that the central bank does not change the real policy rate. So, as IS shifts the output and interest rate will increase. So the short run equilibrium will increase in period t+1 xompared to period t.

b. Assuming that,

t+2= t+1

If the central bank leaves the policy unchanged, then this situation is called NAIRU ( Non- Accelerating Inflation Rate of Unemployment). then the acctual inflation function equation be written as:

  = t+1-  (u-u) + v, where, u= actual unemployment, u= natural unemployment, v= supply shock, ( u- u)= cyclical unemployment). This inertia arises because past inflation infuences expectations of future inflation and as these expectations influence the wage and prices that people set.

Continuing with the same assumptions, at period t+3, the actual inflation will be,

= t+2-  (u-u) + v, because t+3= t+2

c. Consider the period t+2 equilibrium, assuming that, t+2= ( before it was t+2= t+1)

the central bank leaves the real policy unchanged.

so actual inflation in period t+2 compared to period t+1,

  = -  (u-u) + v,

then, the nomonal policy will change by [t+2-  (u-u) + v]- [-  (u-u) + v]= t+2- = t+2- t+1

Now, so actual inflation in period t+3 compared to period t+2,

= t+2-  (u-u) + v, because t+3= t+2

= + t+1-  (u-u) + v

d. Generally, increase in inflation decreases the quantity demanded of a product. So in pereiod t+1 whatever be the output level there is, it will decrease in period t+3.

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