Consider the complete dynamic response of the economy to a temporary rise in government purchases in the AS/AD framework.
(a) Draw the AS/AD graph associated with this shock.
(b) Plot the impulse response function of GDP to this shock, according to the AS/AD model. You do not need to worry about numbers on the vertical axis; just show the general pattern as the economy moves after the shock and eventually returns to steady state.
(c) Plot the impulse response function of inflation to this shock, according to the AS/AD model.
(d) Compare your results in these two stylized plots to the impulse response function from the Smets-Wouters model shown in Figure 15.12.
(e) Using Okun€™s law, what would the impulse response function for hours worked look like in the AS/AD framework? How does this compare to the response in the Smets and Wouters estimated model?

Transcribed Image Text:

FIGURE 15.12 The Dynamic Effects of a Shock to Government Purchases Percent change Percent change -0.5 20 Quarters after the shock 15 20 Quarters after the shock 10 Percent change Percent change 0.4 0.6 0.5 Hours worked 0.2 0.3 1.2 0.1 20 Quarters after the shock 10 15 20 Quarters after the shock 10