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###### 6) Assume that current nominal interest rates, inflation, and expected inflation are currently 2%...

6) Assume that current nominal interest rates, inflation, and expected inflation are 2% at this time.

a) Suppose the Federal Reserve raises interest rates in the economy. Draw a well labeled supply and demand graph showing how they would normally do this and how this affects supply and demand in the money and bond markets.

b) Suppose the Federal Reserve takes this action and expected inflation falls from 2% to 1%. Show the effect of this change on the supply and demand graphs for the money market and the bond market (draw new graphs, do not use the same graphs drawn in part a).

c) Taking part a) and part b) together, would the Fed rate action be likely to be greater or less than the standard liquidity effect? Briefly justify your answer.

d) Assume nominal interest rates are now 2.5% due to Fed actions, expected inflation is 1%, and current inflation has remained at 2% (due to completely flat prices). Compared to the initial numbers provided at the beginning of this question, are the Fed's actions beneficial to borrowers/lenders/both/neither? Briefly justify your answer.

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