Imagine that, due to the conflict between Russia and Ukraine, oil prices increase so that the economy experiences the shock o¯=3%.
Assume that the shock happens at t=2.
Also, assume that:
at t=1: the inflation rate was 8% (πt=1=8% ), the interest rate was equal to its long-run level (rt=1=r¯=2% ), and there were no other shocks.
Use the following values for the parameters: b=2 , v¯=1, r¯=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 4% at t=2, then it reduces the rate back to 2% at t=3.
Answer the following:
. Use the IS-MP diagram and the Phillips curve to show what happens to the economy at t=2.
Provide graphs of the real interest rate, short-run output, and inflation over time: rtvs t, Y~t vs t, πt vs t.
Your graphs should show these variables for t=1,2, and 3.
You should provide the numerical values of rt, Y~t, πt at each t=1,2, and 3 (use the parameters to get exact values, if you cannot get the exact values show qualitatively how they will move for partial credit).