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You will type answers to questions in Word as much as possible. If an answer requires graphs or
equations you will handwrite those two parts of an answer. Be careful to graph things clearly and in
detail. Handwritten equations should be clearly and carefully written.PLZ USING OWN WORDS
1. An inflation targeting policy would attempt to keep inflation at some constant desired rate and
not be concerned about anything else. Correct answers to Parts B and C of Question 1 illustrate
possible reasons why many central banks across the world have opted to target inflation. These
two analytical results imply that targeting inflation will keep output at its full employment level
in response to some of the most important shocks to an economy. This is a significant result
because even if the central bank didnt know the actual level of full employment output it would
still be able to achieve that level of output simply by holding inflation at a constant rate.
A. What difficulties does a central bank face in trying to implement a policy of attempting to
control the rate of inflation? (for this part of the question ignore the effects of unexpected
movements in the marginal product of labor, as these will be dealt with later)
B. Supply shocks, that is unexpected movements in the marginal product of labor, also affect
the economy. Explain a particular sort of event could happen to an economy that makes the
marginal product of labor higher than it was expected to be.
C. Using the assumption from part B and the AD-A-LRAS model, GRAPH and explain what
happens to output when that shock occurs. In this case, does implementing an inflation
target a monetary policy that keeps inflation keeping it constant at the target rate – make
it easy, somewhat difficult, or impossible to maintain output at its full employment level?
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