a) There is a negative demand shock in an economy, use a Philips curve and an IS-LM diagram to show the effects on equilibrium output, interest rate, and inflation. Assume the Central bank does not intervene.

b) Copy the graph in question a) and add the IP curve, i.e., allowing for international trade and capital flows. Illustrate - in two separate figures - what would happen to equilibrium output, interest rate, and inflation under:

(i) a fixed exchange rate and

(ii) a floating exchange rate

Assume again that the Central Bank does not intervene actively.

c)What economic policy would you suggest to speed up the economic recovery? In the respective set of graphs in b), illustrate your recommended policy action and its effects under:

(i) a floating exchange rate

(ii) fixed exchange rate