Private sector has rational expectations

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Reference no: EM137653

Q. Assume that the economy is in a long run equilibrium where the inflation rate is greater than the optimal rate i' as well as then the central bank acts to reduce the inflation rate to i".

(1) Assume that the central bank decides to take drastic action as well as reduces the inflation rate within one period to i". Also assume that the private sector has adaptive expectations, so that the current expected inflation rate is last period's actual inflation rate. Show in a diagram the path than real aggregate output as well as the inflation rate takes over time.

(2) Now, Assume that the central bank takes the drastic strategy in part 1, but that the private sector has rational expectations so that i=ie. again, show in a diagram the path followed by output as well as the inflation rate over time.

Reference no: EM137653

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