1.Consider an economy described by the following equations:

= E + 0.05(Y - Y^P)

Y^P = 800

Y = 800

E = 4

a.In this economy, compute the inflation rate. (20 points)

b.Suppose that the Fed has the following goals:

Keep the inflation rate at 2 percent.

Keep the economy at maximum employment.

Can the Fed achieve both goals at the same time? Explain your answer. (30 points)

c.Suppose that the priority of the Fed is to keep inflation at 2 percent. What should the Fed do to achieve this goal: buy or sell government bonds in open-market operations? Explain your answer. (30 points)