LO 1 In the basic New Keynesian model, suppose that there is an increase in the future marginal product of capital.

(a) Suppose that the central bank keeps the nominal interest rate at its initial value.

What will be the efect on current inlation and on output?

(b) Suppose that the economy initially faces an increase in anticipated future inlation and a zero output gap. When the shock occurs, what should the central bank do?

(c) Explain your results in parts

(a) and

(b) with the aid of diagrams.