. Consider a closed economy that starts in equilibrium and suffers an unexpected and sus- tained...

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. Consider a closed economy that starts in equilibrium and suffers an unexpected and sus- tained demand contraction each period for 2 periods, i.e. the IS curve progressively shifts inwards each period in t and t + 1. You SHOULD NOT ASSUME that these demand contractions are of the same size. You SHOULD ASSUME that agents have Adaptive Expectations Phillips Curves. (a) Using the idea of the Fisher Rule studied in class, what is the minimum real interest rate that the economy can sustain? Define this quantity mathematically. What is this economic phenomenon known as? [10%] (b) Using an appropriate diagram analyse, with commentary, the response of the economy under the assumption that rt ≥rmin,t for all time periods. Your answer should detail how the economy evolves over time, not just the response of the economy on impact of the shock. [40%] (c) Using an appropriate diagram analyse, with commentary, the response of the economy under the assumption that the real interest rate satisfies the following in time periods t and t + 1. • rt >?min,t rt+1 min, t+1 What constraint does the Central Bank face in period t + 1, and how does this limit central bank policy responses? Your answer should detail how the economy evolves over time, not just the response of the economy on impact of the shock. [40%] (d) What would happen in both cases above if the agents had Rational Expectations Phillips Curves? [10%] . Consider a closed economy that starts in equilibrium and suffers an unexpected and sus- tained demand contraction each period for 2 periods, i.e. the IS curve progressively shifts inwards each period in t and t + 1. You SHOULD NOT ASSUME that these demand contractions are of the same size. You SHOULD ASSUME that agents have Adaptive Expectations Phillips Curves. (a) Using the idea of the Fisher Rule studied in class, what is the minimum real interest rate that the economy can sustain? Define this quantity mathematically. What is this economic phenomenon known as? [10%] (b) Using an appropriate diagram analyse, with commentary, the response of the economy under the assumption that rt ≥rmin,t for all time periods. Your answer should detail how the economy evolves over time, not just the response of the economy on impact of the shock. [40%] (c) Using an appropriate diagram analyse, with commentary, the response of the economy under the assumption that the real interest rate satisfies the following in time periods t and t + 1. • rt >?min,t rt+1 min, t+1 What constraint does the Central Bank face in period t + 1, and how does this limit central bank policy responses? Your answer should detail how the economy evolves over time, not just the response of the economy on impact of the shock. [40%] (d) What would happen in both cases above if the agents had Rational Expectations Phillips Curves? [10%]

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a The minimum real interest rate that the economy can sustain is the natural rate of interest which is the rate of interest that is consistent with full employment and price stability Mathematically t... View the full answer