econnomices exercises

Monetary Policy (EC470) Homework 4

Giorgi Nikolaishvili

August 9, 2021

Exercise 2 (Policies for Economic Stability)

We have assumed that the coefficients in the Taylor rule, aY and aπ, are both positive. Under this assumption, the rule guides the economy back to long-run equilibrium after a shock. The output gap Ỹ eventually returns to zero, and inflation returns to its long-run level πT .

Part (a)

Suppose the inflation coefficient aπ is positive, but the output coefficient aY is zero. Does the economy still return to equilibrium with Ỹ = 0 and π − πT after a shock? Explain.

Part (b)

How is the answer to Part (a) different if aY is positive and aπ is zero? Explain.

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