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Inflation in the country of Hypothetica is currently 5%, above the target range of its central...

  1. Inflation in the country of Hypothetica is currently 5%, above the target range of its central bank.
  1. What does this tell you regarding Hypothetica’s likely output gap? Illustrate it using an AS-AD diagram, and briefly explain your diagram                         
  2. In this situation, what is the central bank likely to do with regard to monetary policy? Briefly explain your answer and state also what is likely to occur to the price level and output at the end of this process (there is no need to draw a diagram, but you can if you feel it helps you explain your answer)   
  3. What happens if the central bank does not intervene? Will the economy eventually return to long-run equilibrium (potential GDP)? Briefly explain your answer and state also what is likely to occur to the price level and output at the end of this process (there is no need to draw a diagram, but you can if you feel it helps you explain your answer).        

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Rahul Sunny answered 2 years ago
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