An article on Reuters discussing a Reserve Bank of India (RBI) monetary policy meeting in early 2017, stated that the RBI “changed its stance to ‘neutral’ from ‘accommodative,’ saying it would monitor inflation.” The article noted that “the decision to hold [the interest rate that is the RBI’s equivalent of the federal funds rate constant] is a risk, as private forecasts are more pessimistic [about economic growth] than the RBI.”
a. Draw a dynamic aggregate demand and aggregate supply graph to show where the RBI expected real GDP to be relative to potential GDP in 2017 if it kept the target interest unchanged. Assume, for simplicity, that real GDP in India in 2016 equaled potential GDP. Briefly explain what is happening in your graph.
b. In the same graph, show where the private forecasters who are more pessimistic about growth see the economy in 2017. Briefly explain what is happening in your graph.