Note: The answer should be typed.

Please draw a diagram from questions b to e based on the question 7. Consider the ASAD model with exchange rates introduced in section 5 of these notes, Throughout this question, assume that the zero lower bound is never reached and ignore the vertical part of the AD curve in your graphs and answers. (a) Suppose that the inflation target of the US (the domestic economy) central bank equals 2%, and that the long-run marginal product of capital in the US equals 16. What are the values of the US real interest, the world real interest rate, US inflation and inflation expectations, and the US nominal interest rate in long-run equilibrium? (b) Draw the long-run equilibrium of the US economy in the ASAD diagram. Label the long-run equilibrium as point A (c) In period 0, the US is in LR equilibrium. Suppose that in period 1, a recession in the rest of world causes foreign central banks to lower the foreign nominal interest rate. What happens to the real interest rate in the rest of the world? Explain how this affects the AD and AS curves in period 1. Draw your answer in the diagram, and use it to the find the new equilibrium of the US economy in period 1. What happens to US short-run output, inflation, consumption, 12 investment, government spending, and net exports? What happens to the real exchange rate of the US? (d) Assume that the world real interest rate remains at a lower level for some time. Explain what happens to the AS and AD curves in period 2. Draw your answer in the diagram you drew for (c), and mark the equilibrium in period 2 as point C. Compared to period 1, how do short-run output and inflation in the US change? Compared to period 1, what happens to the US real interest rate and its real exchange rate? (e) In your diagram, mark the equilibrium where the US economy will move after some time as point D. Compared to the LR equilibrium you marked as point A, what happens to inflation and output, and the real exchange rate? Explain how the composition of output in the U.S. has changed between the equilibrium at point A and point D