Consider an economy described by the following equations: LRAS curve: = 7 AS curve: = IS curve: = 6 0.5 where output is measured in trillions of dollars. The MP curve is = 9 + as long as the nominal interest rate is > 0 (i.e. not at the zero lower bound).

i) Suppose that inflation expectations are adaptive, meaning that inflation expectations take the value of current inflation = . Then, according to the Fisher equation, if nominal interest rates cannot be negative then the real interest rate must satisfy:

a)

b)

c)

d)

ii) At which level of inflation is the central bank no longer able to follow the Taylor principle? (i.e. at which level of inflation does the MP curve have a "kink"?)

a) = 4.5

b) = 0

c) = 4.5

d) there is not enough information