The medium-run equilibrium is characterized byfour conditions:

• Output is equal to potential output Y = Y_n.
• The unemployment rate is equal to the natural rate u = u_n.
• The real policy interest rate is equal to the natural rate of interestr_n where aggregate demand equals Y_n.
• The expected rate of inflation ^e is equal to the actual rateof inflation .

a. If the level of expected inflation is formed so pe equals(-1), characterize the behavior of inflation in a medium-run equilibrium.

b. If the level of expected inflation is , what is the level ofactual inflation in the medium-run equilibrium?

c. Write the IS relation as Y = C(Y - T) + I(Y,r + x) + G.Suppose r_n is 2%. If x increases from 3 to 5%, how must the central bank change rn to maintain the existing medium-run equilibrium. Explain in words.

d. Suppose G increases. How must the central bank change rnto maintain the existing medium-run equilibrium? Explainin words.

e. Suppose T decreases. How must the central bank change r_nto maintain the existing medium-run equilibrium? Explainin words.

f. Discuss: In the medium run, a fiscal expansion leads to anincrease in the natural rate of interest.