Problem 2. (Final Exam, Spring 2021) Use the IS-MP-PC framework to answer the following questions. Assume that the economy starts in period 0 in the no-shock long-run equilibrium, in which a=0,R=r=2%,o=0,Y~=0, and =0, with 0=4%. Assume also that the sensitivity coefficient in the Phillips curve is v=1, and the sensitivity coefficient in the IS curve is b=2. Be sure to draw the relevant IS-MP-PC diagrams for each of your answers below. 1. Suppose that in period 1 the economy experiences a negative aggregate demand shock a=1 that lasts for one period. However, the Fed incorrectly estimates this shock to be twice as large in magnitude, that is, equal to 2. Based on its estimate, the Fed implements monetary policy with the aim of keeping the rate of inflation constant. Find the values of the real interest rate, short-run output, and inflation in period 1 . 2. Having observed the results of its first-period policy, the Fed realizes the mistake and wants to make up for it in period 2. What should the Fed do to bring the inflation rate back to its original value of 4% ? Specifically, find R2 and Y~2 and illustrate the full story (events in periods 1 and 2) on the IS-MP-PC diagrams. Mark the points at which the economy is located in periods 1 and 2. 3. Redo part 2 under an additional assumption that an inflation shock o=1 happens in period 2 (which the Fed estimates correctly). 4. Now assume that b=4/3. Compare this case to the original one by illustrating the events of period 1 for both cases on the same set of IS-MP-PC diagrams and clearly marking the corresponding equilibrium points. Problem 2. (Final Exam, Spring 2021) Use the IS-MP-PC framework to answer the following questions. Assume that the economy starts in period 0 in the no-shock long-run equilibrium, in which a=0,R=r=2%,o=0,Y~=0, and =0, with 0=4%. Assume also that the sensitivity coefficient in the Phillips curve is v=1, and the sensitivity coefficient in the IS curve is b=2. Be sure to draw the relevant IS-MP-PC diagrams for each of your answers below. 1. Suppose that in period 1 the economy experiences a negative aggregate demand shock a=1 that lasts for one period. However, the Fed incorrectly estimates this shock to be twice as large in magnitude, that is, equal to 2. Based on its estimate, the Fed implements monetary policy with the aim of keeping the rate of inflation constant. Find the values of the real interest rate, short-run output, and inflation in period 1 . 2. Having observed the results of its first-period policy, the Fed realizes the mistake and wants to make up for it in period 2. What should the Fed do to bring the inflation rate back to its original value of 4% ? Specifically, find R2 and Y~2 and illustrate the full story (events in periods 1 and 2) on the IS-MP-PC diagrams. Mark the points at which the economy is located in periods 1 and 2. 3. Redo part 2 under an additional assumption that an inflation shock o=1 happens in period 2 (which the Fed estimates correctly). 4. Now assume that b=4/3. Compare this case to the original one by illustrating the events of period 1 for both cases on the same set of IS-MP-PC diagrams and clearly marking the corresponding equilibrium points