. Consider three alternative policies, each with a different set of outcomes in

Question

. Consider three alternative policies, each with a different set of outcomes in terms of output and inflation, as shown in following table:
Output Output Output Inflation Inflation Inflation
Policy A Policy B Policy C Policy A Policy B Policy C
500.0 500.0 500.0 3.0 3.0 3.0
515.0 500.0 520.0 3.0 2.8 3.2
530.5 520.0 535.0 3.0 2.0 4.0
546.4 540.0 550. 3.0 1.5 4.5
562.8 562.8 562.8 3.0 1.5 4.5

Potential output is 500 in period 1 and rises 3% per year. The Fed's objective function is ?{-2+(w x -2)}
yt nt
where w=1, and the inflation target is 2.0%.
A. Calculate the value of the objective function over the 5-year period for each of the 3 policies.



B. Which policy is best? Why?

C. Would the answer to part B change if w =5? If so explain.

Explanation / Answer

value of objective function=m total rise=500(1+.03)^5=580 -80/500=m^2+2(m-2) m=1.27 first policy is best as output percentage is uniform every year when w=5 -5*80/500=m^2+2(m-2) m=1.049

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