# Question

Suppose that the inflation rate is higher than i*, that the central bank announces it will reduce the inflation rate, and that it actually proceeds to do this. Answer the following:

(a) Suppose that the private sector believes the central bank announcement. What are the effects on the inflation rate and real output? Show this in a diagram.

(b) Suppose that the private sector does not believe the central bank announcement. What are the effects on the inflation rate and real output now? Show this in a diagram.

(c) Explain your results in parts (a) and (b).

(a) Suppose that the private sector believes the central bank announcement. What are the effects on the inflation rate and real output? Show this in a diagram.

(b) Suppose that the private sector does not believe the central bank announcement. What are the effects on the inflation rate and real output now? Show this in a diagram.

(c) Explain your results in parts (a) and (b).

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