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Econ 301

Spring 2023

Problem Set 2A

Due Thursday May 25 start of class

I. Monetary Policy with Uncertainty About the Neutral Rate

Consider the following economy:

In this economy the Fed is uncertain about the natural rate of unemployment:  the current unemployment rate could be lower than the natural rate or higher than the natural rate.  The current level of output is shown as Y0 . The economy in

graphical terms is given by Figure 1:

Figure 1

1.    Label the curves.

2.    If the economy is initially producing Y0  is the inflation rate above or below the target rate of inflation when the natural rate of output is less than Y0 ?  Explain, using the graph as part of your answer.

3.    In (2), can the monetary authority change the policy rate to get the economy to the natural rate of output? Explain, using the graph as part of your answer.

4.    If the economy is initially producing Y0  is the inflation rate above or below the target rate when the natural rate of output is greater than Y0 ?  Explain, using Figure 2 (below) as part of your answer.

Figure 2

5.    Can the monetary authority always change the policy rate enough to get the economy to the natural rate of   output? Explain, using the graph as part of your answer.  How does your answer depend on the target rate of inflation?

II. Solow Growth Model

Suppose that there is an increase in the depreciation rate in the Solow growth model.  Starting from the initial long-run equilibrium show the effect this will have on

a.    output per worker

b.    capital per worker

c.    the rate of growth during the transition

d.    the rate of growth in the long run

Clearly label the vertical and horizontal axes and the long-run equilibria. Use arrows ( → ) to indicate movement from one equilibrium to another.