Suppose that consumer confidence unexpectedly rises six months before the central bank detects the change. Compared to your answer to Problem 1, what happens to inflation and output in that interval? How does monetary policy return the economy to long-run equilibrium at the initial inflation target?
Problem 1
Consider again the rise in consumer confidence described in Problem 2. What would happen to inflation and output in the long run if the central bank remained committed to its original inflation target and responded with an immediate policy tightening? Compare the outcome to that in Problem 10 using the aggregate demand-aggregate supply framework.
Problem 2
Starting with the economy in long-run equilibrium, use the aggregate demand- aggregate supply framework to illustrate what would happen to inflation and output in the short run if there were a rise in consumer confidence in the economy. Assuming the central bank takes no action to offset this rise in confidence, what would happen to inflation and output in the long run? What policy adjustment is the central bank undertaking?