Suppose that natural real GDP is constant. For every 1 percent increase in the rate of inflation above its expected level, firms are willing to increase real GDP by 2 percent. The output ratio is initially 100 and the inflation rate equals 2 percent.
The government chooses to follow a neutral policy in response to this shock. Illustrate what will be the growth rate of nominal GDP? Elucidate what will be the new rate of inflation? What will be the output ratio?