3. Consider our 3period monetary policy model from Unit 2 (starting on slide 39). Remember that in the model we have downward nominal wage rigidity (nominal wages can't fall). Let 0' = .5 and 7 = 1. Assume the current price level is P1 = 1 and the rm's price markup is 1.1 (so the nominal wage, W1 = real wage (Wl/Pl) m .9). (a) Start with the household's labor supply condition derived on slide 43. Under full employment, what must labor supply be equal to? When Y} = Lt and Ct = Y}, what must labor demand be equal to? Find the level of consumption/ output consistent with full employment. (b) Now take the household's rst period Euler equation Suppose ,61 = .98. Suppose further than households know that P2 = 1.1 and C2 = .8. Solve for the nominal interest rate, 211 that results in full employment. (c) Now suppose households become nervous and their discount rate, ,61 rises to 1.3. What is the 211 associated with full employment now? Is this feasible? (d) Has anything happened (yet) to the domestic price level? Given your answer, would we expect any changes in the current exchange rate between this country and its neighbor? HINT: Think about how the relative price level affects the future exchange rate. (e) Can the central bank use any other tools to boost demand? What will that do to prices tomorrow P2? What would the effect be on the future exchange rate? The current exchange rate?