b) Assume that the price level in an economy is stable with expected inflation initially equal to 3% in period 0. Further assume the economy is then hit by an expansion at the beginning of period 1, and employment remains at a constant high level until the beginning of period 4. With time period on the xaxis and inflation rate on the y-axis:

(i) Plot the path of the bargaining gap (assume it is equal to 1%), inflation and expected inflation from period 1 to the end of period 4. (2)

(ii) Provide some reasons for why the bargaining gap might disappear after period 4, and state any other assumptions you are making. (2)

c) Explain how an increase in the central banks policy interest rate would affect the exchange rate through the market for financial assets (such as government bonds). What impact would this have on aggregate demand? (6)

d) Define the gold standard and discuss whether being on this monetary system prolonged the Great Depression.