Imagine that, due to the conflict between Russia and Ukraine, oil prices
increase so that the economy
experiences a shock o = 2%. Assume that the shock happens at
t=2.
Also, assume that:
• at t=1: the inflation rate was 7% (
TI=1 = 7% ), the interest rate
was equal to its long-run level (
T=1 = 7 = 2% ), and there were
no other shocks. • Use the following values for the
parameters: b = 1, ¢ =
§ = 2%.
For each of the following cases: • CASE A: Suppose the central bank keeps the real interest rate
unchanged. • CASE B: Suppose now that the central bank increases the rate to 6% at t=2, then it reduces the rate
back to 2% at t=3.
Use the IS-MP diagram and the Phillips curve to show what happens to the
economy at t=2.