In recent years, many central banks have placed increased emphasis on controlling inflation. Suppose the central bank of the nation of Economica decides that it will move interest rates sharply whenever inflation differs from its desired target of 1 percent. Previously, policymakers in Economica had adjusted interest rates only slightly in response to inflation.
(a) How will this switch in policy affect the central bank's monetary policy rule?
(b) How will it affect the slope of the ADI curve?
(c) Suppose Economica suffers an inflation shock that increases inflation. Use a graph to illustrate how output and inflation respond under both the old and the new policy rules.