Suppose that, over time, the economy is subjected to positive and negative shocks to current total factor productivity. Assume that the central bank responds optimally to these shocks and that the central bank is not constrained by the zero lower bound. Use the basic New Keynesian model, and assume that the central bank's loss function takes the form , where k and z are parameters.
Part 2
a. Suppose, in the central bank's loss function, that k0 and z0.
This implies that over time, positive shocks to current total factor productivity will be accompanied by
â–¼
possibly increases, decreases, or no change
decreases
no change
increases
in inflation,
â–¼
decreases
possibly increases, decreases, or no change
no change
increases
in aggregate output,
â–¼
no change
decreases
increases
possibly increases, decreases, or no change
in the nominal interest rate, and
â–¼
increases
decreases
no change
possibly increases, decreases, or no change
  in the output gap. Negative shocks to current total factor productivity will be accompanied by the opposite changes.