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Unformatted text preview: Monetary Policy Rules and Aggregate Demand Earlier we assumed that t R was an exogenous policy variable Now consider the possibility of a policy rule The Central Bank sets t R as a function of observable variables Assume that: ) ( π π + = t t m r R or ) ( π π = t t m r R The Central Bank’s target inflation rate is π The parameter m governs the magnitude of policy responses The policy rule attempts to offset undesired changes in inflation The AD Curve Combine IS and the Monetary Policy Rule ) ( : e Policy Rul ) ( ~ : IS π π = = t t t t m r R r R b a Y Therefore: ) ( ~ : AD π π = t t m b a Y Movements along AD: changes in t Y ~ and t π Shifts in AD: Changes in a Changes in π t Y ~ t π π AD The Aggregate Supply Curve Plot the Phillips Curve against π π ∆ not , t o Y o Y t t t t t t + + = + = = ∆ ~ : Supply Aggregate ~ : Curve Phillips 1 1 υ π π υ π π π Movements along AS: changes in t Y ~ and t π Shifts in AS: Changes in 1 t π Changes in o The Steady State In the steady state, the rate of inflation is constant We therefore expect that t t e t π π π = = 1 AS therefore requires that for , = o ~ = Y t Y ~ t π 1 t π AS AD then requires that for , = a π π = t Inflation will equal the target inflation rate The Steady State: π π = 1 t t Y ~ t π π AD AS The Algebra of AD and AS o Y m b a Y t t t t t + + = = ~ ) ( ~ 1 υ π π π π Rearrange: o Y m b a m b Y t t t t t + = + + = + 1 ~ ~ π π υ π π Solve: υ π υ π υ π υ π π m b m b o a m b o m b m b a Y t t t t + + + + = + = 1 1 ) ( ~ 1 1 Shortrun Equilibrium Endogenous Variables: t t Y π , ~ Exogenous and Predetermined Variables: 1 , , , t a o π π Parameters: m b , , υ Effects of Disturbances An Inflation Shock – A oneperiod increase in...
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 Spring '08
 McCafferty
 Inflation, Monetary Policy, Fed, Yt

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