Consider the following news article for problem 1 and 2: Nobody, including the Fed, knows the lowest unemployment rate that's consistent with stable inflation There is a very specific critique of the idea that Fed think they know the level of u*. That's not an asterisk it's a star; this variable is called "u-star" and it's a very big deal in Fedville. It is the unemployment rate that Fed economists believe to be consistent with stable inflation. In other words, it's the unemployment rate at full employment. The Fed thinks that over the long run, u* is 4.8 percent. That is, as the economy moves toward full resource utilization and the labor market closes in on full employment, the unemployment rate will settle in at this level. The fact that the current rate 4.6 percent; let's call it u is already below their long-term u* is not a problem; short-term fluctuations around u* are acceptable to them. But that's why they're raising rates.

1. Briefly explain how the Fed economists estimate 'u-start' (natural rate of unemployment) using inflation rate and unemployment rate data. (25 points)

2. Current unemployment rate is 4.6 percent while the natural rate of unemployment is 4.8 percent. Explain why the Fed raise the interest rate in the financial market using IS-LM-PC model. (30 points)