Econ 100/5C: Intermediate Economics III
Spring 2017: Jenkins Name:
ID#:
UCInetID: Extra Credit Assignment: Exercises
June 5, 2017 1. (a) Suppose that the central bank has an inflation target of π T = 2.5. Compute the loss L
to the central bank when the actual inflation rate is 0, 1, 2.5, and 3. You don’t have to
show your work. (b) When π T = 2.5, what is the value of π that minimizes the central bank’s loss function
given in equation (3)? You don’t have to show your work. 1 2. (a) Rewrite the aggregate supply equation (2) to express the output gap y as a function of
π and π e . You don’t have to show your work. (b) Use your answer to part (a) to eliminate y from the IS equation (1) and solve for the
real interest rate r as a function of π, π e , and . You don’t have to show your work. 2 (c) Suppose that the public expects that the inflation rate will equal the central bank’s
target (i.e., π e = π T ). Use the equation for the real interest rate that you derived in
2(b) to compute the appropriate real interest rate for each combination of π T , π e , and
. πT πe  2.5 2.5 0 2.5 2.5 0.5 2.5 2.5 1 2.5 2.5 -0.5 2.5 2.5 -1 r 3 (d) Now, suppose that the public expects that the inflation rate will equal the central bank’s
target plus 1 percent. (i.e., π e = π T + 1). Use the equation for the real interest rate that
you derived in 2(b) to compute the appropriate real interest rate for each combination
of π T , π e , and . πT πe  2.5 3.5 0 2.5 3.5 0.5 2.5 3.5 1 2.5 3.5 -0.5 2.5 3.5 -1 r (e) Compare your answers to part (d) with your answers to part (c). How does the increase
in the expected inflation rate affect the appropriate value of the real interest rate? 4

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