be affected by the political turmoil, economic fluctuations and societal changes. Let us assume that our expectations for the inflation are subject to some random shocks and let's model it as Et-1πt = πt-1 +Nt-1. Here nt-1 is random shock (i.e., increase in the price of fuel). This shock is normally equally zero, but we know it deviates from zero when some events beyond past inflation (contrast to adaptive expectation) causes expected inflation to change. a) Firstly, derive both the dynamic aggregate demand (DAD) equation and the dynamic aggregate supply (DAS) equation in this slightly more

be affected by the political turmoil, economic fluctuations and societal changes. Let us assume that our expectations for the inflation are subject to some random shocks and let's model it as Et-1πt = πt-1 +Nt-1. Here nt-1 is random shock (i.e., increase in the price of fuel). This shock is normally equally zero, but we know it deviates from zero when some events beyond past inflation (contrast to adaptive expectation) causes expected inflation to change. a) Firstly, derive both the dynamic aggregate demand (DAD) equation and the dynamic aggregate supply (DAS) equation in this slightly more

Economics:

10th Edition

ISBN:9781285859460

Author:BOYES, William

Publisher:BOYES, William

Chapter14: Macroeconomic Policy: Tradeoffs, Expectations, Credibility, And Sources Of Business Cycles

Section: Chapter Questions

Problem 9E

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Problem 5. Suppose people's inflation expectations are subject to ran- dom shocks: at time t-1, expected inflation in time t is Et-1t = Tt-1+t-1 where nt-1 is a random shock with mean zero but deviates from zero when some event beyond past inflation causes expected inflation to change. Also, Ett+1 = πt +Nt. 3 A. Derive the DAD and DAS equations. Hint: For DAS, express T as a function of (Y - Y); for DAD, express Y, as a function of (T- πt). B. Suppose the economy experiences an inflation scare: in period t, people believe that inflation in t+1 will be higher so nt> 0 (but for this period only). What happens to DAD and DAS in t? Explain what happens to output, inflation, nominal interest rate, and real interest rate. Show a graph and provide labels for equilibrium points (A, B, C, etc.) as needed.
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.) Suppose people's inflation expectations are subject to ran- dom shocks: at time t-1, expected inflation in time t is Et-1t = πt-1+t-1 where n-1 is a random shock with mean zero but deviates from zero when some event beyond past inflation causes expected inflation to change. Also, Ett+1 = πt + nt.