Recall that an alternative assumption about the behavior of inflation behavior is that inflation expectations are anchored. This problem asks you to analyze the implications of anchored inflation expectations for the 1iquidity trap.

a. Suppose that expected inflation equals * regardless of the current level of inflation.

i. Describe the MP curve for a given actual inflation rate. Does it still have a flat

portion? If so, what is r on the flat portion? If not, why not?

ii. How, if at all, does a fall in actual inflation affect the MP curve?

iii. Use your answers to (i) and (ii) to show the shape of the AD curve.