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Alternatively for one each possible interest rate i

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Unformatted text preview: tted in Figure 2B. (Alternatively, for one each possible interest rate i, the schedule shows the level of national income for the which investment equals savings, as this is equivalent to equality between supply of and demand for funds.) The monetary policy reaction function of the central bank, indicating how the central bank’s interest-rate target will vary with the level of economic activity, is shown by the curve MP in this figure.3 If If we suppose that the MP curve is drawn for a given inflation rate, then the upward upward slope shown indicates a response of interest rates to the level of output (relative tive to trend or to potential), of a kind implied, for example, by the “Taylor rule” (Taylor, 1993)—that is, higher interest rates when output is high relative to trend or potential, and lower interest rates when output is low relative to trend or potential. In this case, the equilibrium level of output determined in Figure 2B depends on the inflation rate; a graph showing how the equilibrium level of output would vary with with inflation yields an aggregate demand rela...
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