Consider the following rational expectations model: y, B(p, -EP), B>0; m-p=y. Suppose that the monetary authorities...

  

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Consider the following rational expectations model: y, B(p, -EP), B>0; m-p=y. Suppose that the monetary authorities set money supply in each period according to the following rule, perfectly known to agents: m, a, +a,m +8,, where 8, is a systematic component stochastic, unpredictable component with E8, =0 and a,,a, >0. We solved this model at the lecture and demonstrated that B Y₁ (m-Em₂) = -8, Suppose that the above 1+B В 1+B stated rule was the rule that governed m for many years. Suppose that one studies the past behavior of y and m and runs a regression of the form: y, λ +λm, +₂m₂_₁+U₂. (i) Show that if the economy is really represented by the above given equations, then he would find λ, to be positive. Can you conclude that systematic monetary policy has real effects? (ii) What happens with output if central bank increases money supply by raising a ? Explain carefully. Consider the following rational expectations model: y, B(p, -EP), B>0; m-p=y. Suppose that the monetary authorities set money supply in each period according to the following rule, perfectly known to agents: m, a, +a,m +8,, where 8, is a systematic component stochastic, unpredictable component with E8, =0 and a,,a, >0. We solved this model at the lecture and demonstrated that B Y₁ (m-Em₂) = -8, Suppose that the above 1+B В 1+B stated rule was the rule that governed m for many years. Suppose that one studies the past behavior of y and m and runs a regression of the form: y, λ +λm, +₂m₂_₁+U₂. (i) Show that if the economy is really represented by the above given equations, then he would find λ, to be positive. Can you conclude that systematic monetary policy has real effects? (ii) What happens with output if central bank increases money supply by raising a ? Explain carefully.

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Answer i If the economy is really represented by the above given equations then he would find 1 to be positive However this does not necessarily mean ... View the full answer