Discuss the trend in the inflation rates between the U.S. and European countries during this period.

b. Explain why, with the exception of the U.S., monetary policies were ineffective under the Bretton-Woods fixed exchange rate system. (Hint: you should use the DD-AA diagram for this question).

c. Explain the observed relation between the inflation rates in the U.S. and European countries. Use the diagram of internal balance and external balance to support your arguments.

The following table shows the inflation rates in the U.S. and European countries at the end of 1960s and the early 1970s. Table 2: The inflation rates in the U.S. and European countries during 1966-1972 (unit: %) Country Britain France Germany Italy United States Source: OECD 1966 3.6 2.8 3.4 2.1 2.9 1967 1968 1969 1970 6.5 5.3 3.4 5.1 5.7 2.6 2.8 1.4 2.1 3.1 4.6 4.4 2.9 1.2 4.2 5.2 6.5 1.9 2.8 5.5 1971 9.7 5.5 5.3 5.2 4.4 1972 6.9 6.2 5.5 5.3 3.2