A. Consider the Taylor rule: rt = (s1)[rt1] + (s2)[r n + ayY + a(t T )]. Assume target inflation at 2% and natural rate of interest at 1.8%. (a) If output gap increase by 1.5% and actual inflation to 4%, how much will be the interest rate increase from 2% if the central bank gives twice more weight to output gap as compared to inflation targeting weight of 0.5? Assume s1 = s2 = 0.5. [Write the Taylor rule first and then compute.

B. Which component of this Taylor rule captures smoothness of interest rate changes? and How?