Suppose that inflation at time t is given by the following equation: = R +...

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Suppose that inflation at time t is given by the following equation: π₁ = R₁ + VÝ₁ +0₁ where all the variables are the same as in the lectures. However, unlike in lectures, assume that = 0.02. That is, people expect the inflation rate to equal 2% in every period. (a) (10 points) Using a version of the Phillips curve with (, - ) on the vertical axis and a graph showing how inflation responds over time, analyze the effect of a one time price shock to the economy. (b) (5 points) The Bank of Canada has a specific mandate to keep inflation around 2%. Given your answer to part a) and our discussion in class, explain the importance that this mandate is a credible commitment. Suppose that inflation at time t is given by the following equation: π₁ = R₁ + VÝ₁ +0₁ where all the variables are the same as in the lectures. However, unlike in lectures, assume that = 0.02. That is, people expect the inflation rate to equal 2% in every period. (a) (10 points) Using a version of the Phillips curve with (, - ) on the vertical axis and a graph showing how inflation responds over time, analyze the effect of a one time price shock to the economy. (b) (5 points) The Bank of Canada has a specific mandate to keep inflation around 2%. Given your answer to part a) and our discussion in class, explain the importance that this mandate is a credible commitment.

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a A onetime price shock to the economy can be represented as an exogenous increase in the overall price level This shock will cause the actual inflati... View the full answer