The dynamic aggregate demand curve is given by: Y₁ = Ỹ — — — (π, — πª) + ε₁ The dynamic aggregate supply curve is given by (inflation expectations are backward looking): π₁ = π₁_₁ +2 + 2(Y₁ - Y)+ V₁ a) The economy was in equilibrium. The rate of inflation was equal to 10%. The central bank reduces inflation target to 2%. Calculate output loss (fall in output) arising from this disinflation policy during the first year of its implementation. Calculate the rate of inflation during the first year of the disinflation policy implementation. b) Use a graph of the dynamic AD-AS curves to show the short and long-run consequences of a reduction in inflation target described in (a). Briefly explain the shifts of the curves.
