Homework 7

1.
We calculate the equilibrium inflation rates by substituting the output function in
the loss function and the setting the derivative of it with respect to ℼ to 0 and
solving.
We get the following results
ℼ1= ε1 + YT
π2 =ε2 +YT
We find out that the equilibrium inflation rates depend on the disturbances and
the level of output target growth.
The total output is given by Y=Y1+Y2= ε1 + ε2 +2YT
We see here the output depends on the disturbances and the target output

2.
Again, we substitute the output functions in the united loss function, and we set
the derivative with regards to π to 0.
Solving that we get the following equation:
π= -(ε1+ ε2)/2 - YT
And the output is Y= - ε1 - ε2
We see here that the equilibrium output does not depend on the target output

3.
If the shocks are independent, then we get both the variances in the monetary
union and the autonomous case as Var(Y)=2* σ2
If the shocks are perfectly correlated, we find the following
For the monetary union:
Var(Y)=4*σ2
For the autonomous case:
Var(Y)=2* σ2
In independent shocks the variances are equal, while under perfect correlated
shocks the monetary union has a larger variance in disturbance.