Question 2 - 10 marks In Chapter 16 we derived the equation for the aggregate demand curve as =+1z1(yy) where y is the log of GDP, is expected inflation, z is a demand shock parameter that is a function of the log of government spending g and consumer confidence , and is given by the equation =1+2b2h where 2>0 and h and b are drawn from the Taylor rule equation i=r++h()+b(yy) Use a diagram to show how the aggregate demand curve changes for each of the following scenarios. a) Some leading economists have spoken out in favour of a policy targeting a higher inflation rate as a way to boost economic activity. Show what happens to the AD curve given an increase in the target inflation rate . b) In order to spur economic recovery following the pandemic, the central bank decides to give a greater weighting to the output gap (yy) in its decisions around setting the interest rate i. Show how this policy change affects the AD curve. c) Finally, because of continuing concerns around inflation cause consumer confidence to fall to lower levels than expected. Show how this will affect the AD curve..

1. Question 2 - 10 marks In Chapter 16 we derived the equation for the aggregate demand curve as
=+1z1(yy) where y is the log of GDP, is expected inflation, z is a demand shock parameter that
is a function of the log of government spending g and consumer confidence , and is given by the
equation =1+2b2h where 2>0 and h and b are drawn from the Taylor rule equation
i=r++h()+b(yy) Use a diagram to show how the aggregate demand curve changes for each of the
following scenarios. a) Some leading economists have spoken out in favour of a policy targeting
a higher inflation rate as a way to boost economic activity. Show what happens to the AD curve
given an increase in the target inflation rate . b) In order to spur economic recovery following the
pandemic, the central bank decides to give a greater weighting to the output gap (yy) in its
decisions around setting the interest rate i. Show how this policy change affects the AD curve. c)
Finally, because of continuing concerns around inflation cause consumer confidence to fall to
lower levels than expected. Show how this will affect the AD curve.