The dynamic aggregate demand curve is given by: Y,₁ = Y* - (7₁ −7°) + 6, 3 The dynamic aggregate supply curve is given by (inflation expectations are backward 1 looking): 7, = ₁₁₁ + _T₁ = π[₁_1 + 2/2 (Y₁ - Y*) + v₁ The economy was in equilibrium and the rate of inflation was on target level when a negative supply shock hit the economy, v-6. The shock was short lived, that is from t+1 onwards v=0. a) Suppose that in response to a negative supply shock the government implements a policy aimed at maintaining output at the potential level. Calculate the change in aggregate spending in period t necessary to achieve this objective. b) Suppose that, in response to a negative supply shock, the government implements a policy aimed at keeping inflation on target. Calculate the change in aggregate spending in period t necessary to achieve this objective.
