The text analyzes the case of a temporary shock to the demand for goods and serv

Question

The text analyzes the case of a temporary shock to the demand for goods and services. Suppose, however, that "Et" were to increase permanently. What would happen to the economy over time? In particular, would the infl ation rate return to its target in the long run? Why or why not?
(Hint: It might be helpful to solve for the longrun equilibrium without the assumption that "Et" equals zero.) How might the central bank alter its policy rule to deal with this issue?

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Explanation / Answer

Demand shocks refer to the sudden increase or decrease in demand due to certain external factors like changes in tax rate, money supply, government spending, fall in brand image etc. Temporary demand shocks generally lead to a depreciation of the real exchange rate. So, overtime it will lead to an increase in country’s exports and fall in imports.

[P.S. the question does not seem to be complete. No diagram or reference is attached for Et]

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