12) ( 24 ) Janet Yellen, the US Treasury Secretary, has said that the Federal Reserve "has tools" to deal with inflation, if inflation does increase due to the recovery from the 2020 Pandemic Recession. Assume that in 2023, inflation = expected inflation = 6% and the bargaining gap = 0%. Also assume that for all years, expected inflation = inflation in the previous year.

a) Suppose in 2024, The Fed, (the US central bank) changes the real policy interest rate to make inflation equal 2% in 2025 and then in 2026 changes the real policy interest rate to stabilize inflation at 2%. Copy and complete the following table in your bluebook (You have enough information to complete the table!): Year Expected inflation Bargaining gap Inflation 2023 6% 0% 6% 2024 2025

b) Given your answer from part a), how does the Fed change real interest rates from 2023 to 2024 and from 2024 to 2025? (decrease? Increase?)

c) Now draw the three graphs of our macro model, The Labor Market Graph, The Phillips Curve Graph and The Multiplier Model Graph. Indicate what happens in each graph due to the change in the real interest rate from 2023 to 2024 and from 2024 to 2025. Indicate in your graphs, years 2023, 2024 and 2025 and indicate what happens to Real GDP, inflation, employment and the bargaining gap.

d) Given your answers to part c), now use a flow diagram to give a complete explanation for what happens to aggregate demand, output, employment, unemployment, wages, prices and inflation.