2. Suppose now that the Central Bank follows the interest rate rule discussed in

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2. Suppose now that the Central Bank follows the interest rate rule discussed in class. What are the effects of the fiscal shock on short-run output and inflation overtime? Explain (The interest rate rule we discussed was: increases in the interest rate will up along the IS curve and cause short run output to fall.)

3. For two cases of the reaction parameter of monetary policy(m-bar), m-barH and m-barL, with m-barH > m-barL , compare the effects of the fiscal shock on short-run output and inflation in the first period. Explain.  

Explanation / Answer

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