Consider the Phillips curve _t = _t-1 - 0.5(u_t - 0.01).

1. What is the natural rate of unemployment? Graph the short-run and long-run relationships between inflation and unemployment.(5 marks)
2. How much unemployment is necessary to reduce inflation by 3%? Compute the sacrifice ratio. Show your work.(5 marks)
3. Do flexible exchange rates permit a country to pick its own unemployment-inflation trade-off target? (10 marks)