Output---------Output-------Output----------------Inflation------------Inflation
ID: 437610 • Letter: O
Question
Output---------Output-------Output----------------Inflation------------Inflation-------InflationPolicy A------Policy B-------Policy C-------------Policy A------------Policy B------Policy C
500.0--------500.0-----------500.0------------------3.0------------------3.0-------------3.0
515.0--------500.0-----------520.0-----------------3.0-------------------2.8-------------3.2
530.5-------520.0-----------535.0------------------3.0-------------------2.0-------------4.0
546.4-------540.0-----------550.0------------------3.0-------------------1.5--------------4.5
562.8-------562.8-----------562.8------------------3.0-------------------1.5--------------4.5
Potential output is 500 in period 1 and rises 3% per year. The Fed's objective funtion is E{-2+(w x -2)}
yt nt
where w=1, and the inflation target is 2.0%.
A. Calculate the vaule of the objective function over the 5-year period for each of the 3 policies.
B. Which policy is best? Why?
C. Would the answer to part B change if w =5? If so explain.
Explanation / Answer
In order to solve this you must re adjust the inflation target from 2% to whatever is required for that time period. E will represent the output. Lets start with the first one in policy A. It should look like this 500{-2+(w * -3)} Now solve, remember w=1 always. 500{-2+(1 * -3)} 500{-2+(-3)} 500{-5} =-2,500 Here is the rest Policy A== -2500,-2575,-2652.5,-2732,-2814 Policy B==-2500,-2400,-2080,-1890,-1969.8 Policy C==-2500,-2704,-3210,-3575,-3658.2 B. Policy B, it has the least amount of negative output. C. Its already Policy B Hopefully this answered your question, best of luck.
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