Consider two economies, one with a flexible exchange rate and one with a fixed exchange rate. This problem requires you to use the Macroeconomic Simulator available from the Carlin and Soskice website. Begin by opening the simulator and selecting the open economy (flexible exchange rate) version. Then reset all shocks by pressing the appropriate button on the left hand side of the main page. Use the simulator and the content of Chapters 9-12 to work through the following questions:

(a) Apply a permanent 2% negative demand shock. Show the impulse response functions for inflation, interest rates, GDP and GDP growth. (3 points)

(b) Switch to the open economy (fixed exchange rates without endogenous fiscal policy) version of the simulator. Set the degree of inflation inertia to 0.2. Apply a permanent 2% negative demand shock. Show the impulse response functions for inflation, interest rates, GDP and GDP growth. (You may show these on the same charts as the IRFs from part (a).) (3 points)

(c) How long does it take for the economy to return to medium-run equilibrium in each case? Why is the speed of adjustment different? Carefully explain the underlying economics.