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ECON 2450 (11)


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York University
ECON 2450
Frank Marchese

Answers to Practice Exercises on Chapter 10 Analytical Exercise 2 Holding everything else fixed in the Taylor rule, a decrease in r would mean that for any given Y and π, there will be a decrease in r. This shifts down the effective LM curve in Figure (i) below, from LM to 0M . The 1ew intersection point of the IS and LM curves 1 corresponds to a higher equilibrium level of output demanded (equilibrium output * demanded increases from Y to Y 0. In F1gure (ii), the decrease in r increases output demanded for any given inflation rate, shifting the monetary policy reaction function to the right, from MPRF to 0PRF . 1 Figure (i) Figure (ii) Analytical Exercise 3 Denote: r = r +φ × π(−π ′)+δ × ( −Y *) . (i) r = r +φ ×(π −π )+δ ×(Y −Y )+γ ×(ε −ε ) , * (ii) a. Substituting for r, from the Taylor rule (i) into the IS equation (10.16), we obtain * Y = Y0 − Ω× δY − φ′ × (π −π ) , 1− ×Ω 1 − ×Ω 1− ×Ω where Y 0and φ are as in equations (10.18) and (10.19), respectively, while Ω =φ /φ .′ b. Substituting the more general Taylor rule (ii) into the IS equation (10.16), we obtain Y Ω× ×δ Y * φ ′ Ω× γ Y = 0 − − ×(π − π′)+ ×(ε −ε )* 1− ×Ω 1− ×Ω 1− ×Ω 1 δ×Ω . c. Until recently, the Bank of Canada monitored the deviations of the inflation rate from its target level, the deviations of output from its potential level, as well as the deviation of the real exchange rate from its target level when setting r. Hence, the general Taylor rule (ii) was probably the most accurate description of Bank of Canada policy. In the last two years however the high volatility of the real exchange rate has forced the Bank to reconsider its policy and de-emphasize targeting the exchang
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