In the dynamic model of aggregate demand and aggregate supply, if the central bank chooses a small value of $\theta$_$\pi$ , the responsiveness of nominal interest rates to inflation, and a large value of $\theta$_Y, the responsiveness of nominal interest rates to output, then the DAD curve will be relatively _____, and supply shocks will have relatively ____ impacts on inflation than output. A) flat; larger B) flat; smaller C) steep; larger D) steep; smaller

Question

Quizplus · Accepted Answer

When the central bank chooses a large value of the slope of the Phillips curve (F1F1F1S1F1F1F10), it means that nominal interest rates are highly responsive to inflation. This leads to a steep DAD curve as changes in inflation have a large impact on the nominal interest rates. When the central bank chooses a large value for the slope of the IS curve (F1F1F1S1F1F1F10_Y), it means that nominal interest rates are less responsive to output. This also contributes to a steep DAD curve as changes in output have less impact on nominal interest rates. A steep DAD curve will mean that supply shocks (which are represented by shifts in the SAS curve) will have a larger impact on inflation than on output. Hence, the correct answer is (C) steep; larger.

In the Dynamic Model of Aggregate Demand and Aggregate Supply θ\thetaθ

In the Dynamic Model of Aggregate Demand and Aggregate Supply $\theta$