5. Suppose that the economy is hit by an unexpected large negative aggregate demand shock. (i) Using the IS-PC-MR model, provide a detailed period by period explanation of how a negative aggregate demand shock can lead the economy into a deflation trap. [12]

(ii) Explain, using the IS-PC-MR diagrams, how the central bank can intervene to escape the trap? Discuss the limits of the conventional monetary policy in this case? [8

] (iii) Explain how an unconventional monetary policy, like Quantitative Easing for instance, can revive aggregate demand through its impact on the yield curve. [5]

about the real interest rate in the deflationary scenario? [15]