Consider the Real Business Cycle Model with Money and Sticky Prices studied in class. Suppose that the economy is hit by a negative future TFP shock (i.e., z' decreases, using the notation in class). If the Central wishes to close the resulting output gap in the short run, it should:
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Decrease its interest rate target. |
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Do nothing. |
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Decrease the money supply. |
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Increase its interest rate target. |
Correct option is (1).
A negative TFP shock decreases production and aggregate supply, lowering real GDP. To increase real GDP, central bank has to increase aggregate demand by decreasing interest rate target, which will boost investment & aggregate demand.
Consider the Real Business Cycle Model with Money and Sticky Prices studied in class. Suppose that...