# Question: In the New Keynesian model suppose that in the short

In the New Keynesian model, suppose that in the short run the central bank cannot observe aggregate output or the shocks that hit the economy. However, the central bank would like to come as close as possible to economic efficiency. That is, ideally the central bank would like the output gap to be zero. Suppose initially that the economy is in equilibrium with a zero output gap.

(a) Suppose that there is a shift in money demand. That is, the quantity of money demanded increases for each interest rate and level of real income. How well does the central bank perform in relative to its goal? Explain using diagrams.

(b) Suppose that firms expect total factor productivity to increase in the future. Repeat part (a).

(c) Suppose that total factor productivity increases in the current period. Repeat part (a).

(d) Explain any differences in your results in parts (a)-(c), and explain what this implies about the wisdom of following an interest rate rule for the central bank.

(a) Suppose that there is a shift in money demand. That is, the quantity of money demanded increases for each interest rate and level of real income. How well does the central bank perform in relative to its goal? Explain using diagrams.

(b) Suppose that firms expect total factor productivity to increase in the future. Repeat part (a).

(c) Suppose that total factor productivity increases in the current period. Repeat part (a).

(d) Explain any differences in your results in parts (a)-(c), and explain what this implies about the wisdom of following an interest rate rule for the central bank.

**View Solution:**## Answer to relevant Questions

Suppose, in the sticky price model, that there is deficient financial liquidity, as we studied in Chapter and that there is a positive output gap. What will be the effect of a reduction in the central bank's target interest ...Suppose, as in Chapter that in the first model in this chapter there is limited commitment in the credit relationships between the small open economy and the rest of the world. There is some portion of the nation’s capital ...Suppose that better transaction technologies are developed that reduce the domestic demand for money. Use the monetary small open-economy model to answer the following:(a) Suppose that the exchange rate is flexible. What are ...In the Diamond–Dybvig banking model, suppose that the banking contract includes a suspension of convertibility provision according to which the bank allows only the first tN depositors in line in period 1 to withdraw their ...Alter the Diamond-Dybvig model in the following way. Suppose that there are two assets, an illiquid asset that returns 1+r units of consumption goods in period 2 for each unit invested in period 0, and a liquid asset that ...Post your question