Suppose in the NKRE model that from time 0 until time T -1, the natural rate of
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Suppose in the NKRE model that from time 0 until time T -1, the natural rate of interest is r1*, where r1* < -π*, and from time T on the natural rate of interest is r2* > 0. Also, suppose that the central bank can achieve its inflation target from period T onward and that the central bank sets the nominal interest rate to zero from time 0 until time T - 1.
a. What will happen to inflation and output from period 0 until period T - 1. Explain with the aid of a diagram.
b. What can the central bank do about the problem that arises in part (a) Discuss.
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