3. Suppose that people suddenly wanted to hold more money balances. For simplicity, assume Canada is a closed economy.

a. What would be the effect of this change on the economy if the Bank of Canada followed a rule of increasing the money supply by 3 percent per year? Illustrate your answer with a money-market diagram and an aggregate-demand/aggregate-supply diagram.

b. What would be the effect of this change on the economy if the Bank of Canada followed a rule of increasing the money supply by 3 percent per year plus 1 percentage point for every percentage point that unemployment rises above its normal level? Illustrate your answer.

c. Which of the foregoing rules better stabilizes the economy? Would it help to allow the Bank of Canada to respond to predicted unemployment instead of current unemployment? Explain.