a. Suppose the Fed is following the Taylor rule. Suppose the growth rate of potential output is 4 percent, the output gap is 3 percent, the weights on the output gap and inflation gap are each 1/2, the Fed's inflation target is 2 percent, the Fed believes the equilibrium real federal funds rate is 2 percent, and inflation has been 3 percent over the past year. At what rate does the Fed set the federal funds rate? (5 marks)

b. Suppose the Fed thinks that the equilibrium federal funds rate is 2 percent, as in part a above, but in fact the equilibrium real fed funds rate is 3 percent. What do you think will happen to the inflation rate in the long run? (5 marks)