26. Suppose the Bank of Canada's target for inflation is 2 percent. If deviation of output from
full-employment output is 1 percent, and the rate of inflation over the previous four
quarters is 4 percent, what overnight interest rate the Bank should choose if it follows the
Taylor rule?
a. 5.7 percent
b. 4 percent
c. 7.5 percent
d. 3 percent
ESSAYS & PROBLEMS
27. Starting on a Phillips curve with expected inflation equal to 5% and unemployment at its
natural rate, show what happens to unemployment if the Central Bank tries to reduce
inflation, but has no credibility. As time passes and people realize that the inflation rate is
now lower, what happens to the short-run Phillips curve? (3)
28. Assume that the reserve-deposit ratio is 0.2. The Bank of Canada carries out open-market
operations, purchasing $1,000,000 worth of bonds from banks. This action increased the
money supply by $2,600,000. What is the currency-deposit ratio? (3)
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