The medium-run equilibrium is characterized by four conditions: Output is equal to potential output Y = Yn . The unemployment rate is equal to the natural rate u = un . The real policy interest rate is equal to the natural rate of interest rn where aggregate demand equals Yn . The expected rate of inflation p e is equal to the actual rate of inflation p
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The medium-run equilibrium is characterized by four conditions:
Output is equal to potential output, Y=YnY=Yn.
The unemployment rate is equal to the natural rate, u=unu=un.
The real policy rate is equal to the natural rate of interest, r=rnr=rn where aggregate demand equals YnYn.
The expected rate of inflation πeπe is equal to the actual rate of inflation ππ.
a) If expectations of inflation are formed so that πt=πt−1πt=πt−1, characterize the behavior of inflation in a medium-run equilibrium.
b) If the level of expected inflation is πbarπbar, what is the level of inflation in the medium-run equilibrium?
c) Write the IS relation as Y=C(Y−T)+I(Y,r+x)+GY=C(Y−T)+I(Y,r+x)+G. Suppose r_n is 2%. If x increases from 3 to 5%, how must the central bank change rnrn to maintain the existing medium-run equilibrium?
d) Suppose G increases. How must the CB change rnrn to maintain the existing medium-run equilibrium?
e) Suppose T decreases. How must the CB change rnrn to maintain the existing medium-run equilibrium?