This question is about money management.

a) The central bank in a given country is on an inflation target, . Inflation (pi), and inflation expectations (pi e), have been stable and equal to the inflation target (pi x) for some time and, at the same time, output tension, (Y"), has been zero.

For external reasons, general expectations of lower inflation and fall are created. Use the IS and PC curves to analyze the effect of this on real growth (r) output (Y), output elasticity (Y") and inflation (g) next year if:

i) The central bank keeps the nominal interest rate, i , unchanged.

ii) The central bank changes the nominal interest rate so that next year's inflation will be equal to the inflation target.

b) What should the Central Bank do in the circumstances described in point a? (Justify your answer.)