The medium-run equilibrium is characterized by four conditions:
1. Output is equal to potential output Upper Y equals Upper Y Subscript n.
2. The unemployment rate is equal to the natural rate u equals u Subscript n.
3. The real policy interest rate is equal to the natural rate of interest r Subscript n where aggregate demand equals Upper Y Subscript n.
4. The expected rate of inflation pi Superscript e is equal to the actual rate of inflation pi.
Which of the following best characterizes the behavior of inflation in a medium-run equilibrium if the level of expected inflation is formed so pi Superscript e equals pi (negative 1)?
a. If expectations of inflation are formed so that πt = πt-1, characterize the behavior of inflation in a medium-run equilibrium.
b. If the level of expected inflation is πbar, what is the level of inflation in the medium-run equilibrium?
c. Write the IS relation as Y = C(Y-T) + I(Y, r+x) + G. Suppose rn is 2%. If x increases from 3 to 5%, how must th/e central bank change rn to maintain the existing medium-run equilibrium?
d. Suppose G increases. How must the CB change rn to maintain the existing medium-run equilibrium?
e. Suppose T decreases. How must the CB change rn to maintain the existing medium-run equilibrium?