Assume that the price level in an economy is stable with expected inflation initially equal to 3%
Question:
Assume that the price level in an economy is stable with expected inflation initially equal to 3% in period 0. Further assume the economy is then hit by an expansion at the beginning of period 1, and employment remains at a constant high level until the beginning of period 4. With ‘time period’ on the x-axis and ‘inflation rate’ on the y-axis:
(i) Plot the path of the bargaining gap (assume it is equal to 1%), inflation and expected inflation from period 1 to the end of period 4. (2)
(ii) Provide some reasons for why the bargaining gap might disappear after period 4, and state any other assumptions you are making. (2)
(iii) Explain how an increase in the central bank’s policy interest rate would affect the exchange rate through the market for financial assets (such as government bonds). What impact would this have on aggregate demand? (6)
Intermediate Accounting
ISBN: 978-0324659139
11th edition
Authors: Loren A. Nikolai, John D. Bazley, Jefferson P. Jones