Say whether you think the statement is true, false, or uncertain; and support your answer in...

Say whether you think the statement is true, false, or uncertain; and support your answer in a few lines.

1. The real business cycle model suggests that, with aggregate demand unchanged, increases in output would be associated with a decline in inflation.

2. What is the divine coincidence? When and why does it not hold true?

3. Suppose the economy is in a long-run equilibrium when a temporary, favorable aggregate supply shock occurs. Using graphs, show what happens to bring the economy back to long-run equilibrium, assuming that there is no policy response. In words, explain why ìno responseîis the best policy.

4. Comment on the ability of a credible nominal anchor to allow policy makers to exploit a short-run trade-o§ between unemployment and inflation.

Solutions

Expert Solution

1) The real business cycle model suggests that, with aggregate demand unchanged, increases in output would be associated with a decline in inflation.

Solution: True

Explanation: Real business-cycle theory (RBC theory) occurs when the business-cycle fluctuations to a huge extent can be accounted for by real (in contrast to nominal) shocks, thus assuming aggregate demand constant an increases in output would be associated with a decline in inflation.

2) What is the divine coincidence? When and why does it not hold true?

The divine coincidence occurs when the economy experiences aggregate demand shocks or permanent supply shocks, however it does not occurs when nation experiences temporary supply shocks. When either of the first two shocks are experienced by an economy, policymakers can stabilize the inflation and economic activity by enacting policies to shift the aggregate demand curve of the economy and return to long- run equilibrium at potential output. When an economy faces temporary supply shock, the policies that shift the aggregate demand curve to achieve inflation stability will move the economy further away from potential output and those that target at stabilizing economic activity at potential output will lead to the inflation rate move further away from the target rate.

Thus, divine coincidence still remains true when a permanent supply shock occurs however does not always hold up when economy faces temporary shocks

Rahul Sunny answered 1 year ago

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