Engineering Economics

2. The economy begins in the short-run steady state. Political uncertainty leads to a financial shock.

a) Show how a financial shock is represented in the short-run model. Use the IS/MP and AD/AS frameworks to explain how the economy responds to the shock in the short run.

b) Explain how the central bank might use monetary policy to offset the impact of the shock. Write down a simple policy rule for the central bank that incorporates financial shocks. Under what conditions will this rule work?



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