Suppose that the central bank sets its interest rate target to achieve efficiency in response to temporary shocks to total factor productivity. Using diagrams, determine what the economy’s responses will then be to the total factor productivity shocks. How will this differ from what happens in a real business cycle model? Explain your results, and discuss the implications for what the data can reveal about what is the better business cycle model, the real business cycle model or the New Keynesian model.
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