Assume that there are no surprises, with all economic agents and the central bank having full information about shocks that are hitting the economy. Suppose that the central bank adopts a nominal GDP target, and interpret this in the model as a goal of maintaining some constant level of nominal GDP.
(a) Suppose that there is an increase in total factor productivity. What should the central bank do in response, given its goal? What are the effects on aggregate variables? Explain.
(b) Now suppose that there is a positive shift in the money demand function. What should the central bank do? Determine the effects on aggregate variables. Explain.