Chapter 17

Question 1

Natural rate of interest

Answer 1

The real interest rate at which, in the absence of any shock, the demand for goods and services equals the natural level of output

Question 2

Taylor rule

Answer 2

A rule for monetary policy according to which the central bank sets the interest rate as a function of inflation and the deviation of output from its natural level

Question 3

What happens during long-run growth in the dynamic AD-AS model?

Answer 3

Both DAS and DAD increase, causing an increase in Y to the new equilibrium and keeping inflation the same

Question 4

What is the effect of a supply shock in the dynamic AD-AS model?

Answer 4

The DAS curve shifts up due to the supply shock, then slowly moves back down as the supply shock disappears and inflation expectations fall down

Question 5

What is the effect of a demand shock in the dynamic AD-AS model?

Answer 5

Initially increases DAD and leaves DAS constant, increasing output and inflation. The higher inflation causes inflation expectations to increase, increasing DAS until the demand shock disappears, lowering inflation until it goes back to equilibrium

Question 6

What is the effect of a reduction in target inflation in the dynamic AD-AS model?

Answer 6

DAD decreases, lowering output and inflation. Lower inflation reduces inflation expectations which lowers DAS until it reaches equilibrium output and new target inflation

Question 7

Taylor principle

Answer 7

The preposition that the central bank should respond to an increase in inflation with an even greater increase in the nominal interest rate