1. The current rate of unemployment in Maxistan is 4% and the natural rate of unemployment is believed to be 2%.

a. If the Central Bank of Maxistan has all of the same policy tools available to it as the Federal Reserve, what is the appropriate open market operation to correct the current state of the economy? Explain. (NOTE: Your explanation must include the role of excess reserves).

b. Show the effect of the open market operation you described in part (a) on a correctly labeled graph of the money market.

c. What is the difference between the money market and the market for loanable funds (not just the labels... what does each really represent)?

d. What happens to the real rate of interest based on the change in the nominal rate of interest you showed in part b in the long run? Explain (hint: use Fischer equation in your explanation)