5. Expectations and the Phillips curve The following graph shows an economy in long-run equilibrium at point A (grey star symbol). The vertical line is the long-run Phillips curve (LRPC). The downward-sloping curve labeled SRPC is the short-run Phillips curve passing through point A. INFLATION RATE (Percent) SRPC LRPC 0 ° 1 2 3 5 6 7 8 UNEMPLOYMENT RATE (Percent) +. B SRPC2 D (?) Which of the following is true along SRPC₁? O The expected inflation rate is 5%. The natural rate of unemployment is 3%. O The actual unemployment rate is 6%. Suppose that the Fed suddenly and unexpectedly decreases the money supply in an effort to reduce inflation. As a result of this unanticipated action, actual inflation falls to 3%. On the previous graph, use the black point (plus symbol) to illustrate the short-run effects of this policy. Now, suppose that-after a period of 3% inflation-households and firms begin to expect that the inflation rate will continue to be 3%. On the previous graph, use the purple line (diamond symbol) to draw SRPC2, the short-run Phillips curve that is consistent with these expectations, assuming that it is parallel to SRPC. Finally, use the orange point (square symbol) to indicate the new, long-run equilibrium for this economy.
5. Expectations and the Phillips curve The following graph shows an economy in long-run equilibrium at point A (grey star symbol). The vertical line is the long-run Phillips curve (LRPC). The downward-sloping curve labeled SRPC is the short-run Phillips curve passing through point A. INFLATION RATE (Percent) SRPC LRPC 0 ° 1 2 3 5 6 7 8 UNEMPLOYMENT RATE (Percent) +. B SRPC2 D (?) Which of the following is true along SRPC₁? O The expected inflation rate is 5%. The natural rate of unemployment is 3%. O The actual unemployment rate is 6%. Suppose that the Fed suddenly and unexpectedly decreases the money supply in an effort to reduce inflation. As a result of this unanticipated action, actual inflation falls to 3%. On the previous graph, use the black point (plus symbol) to illustrate the short-run effects of this policy. Now, suppose that-after a period of 3% inflation-households and firms begin to expect that the inflation rate will continue to be 3%. On the previous graph, use the purple line (diamond symbol) to draw SRPC2, the short-run Phillips curve that is consistent with these expectations, assuming that it is parallel to SRPC. Finally, use the orange point (square symbol) to indicate the new, long-run equilibrium for this economy.
Chapter17: The Philips Curve And Expetactions Theory
Section: Chapter Questions
Problem 1SQP
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Question
Transcribed Image Text:2
3
5
6
UNEMPLOYMENT RATE (Percent)
Which of the following is true along SRPC?
The expected inflation rate is 5%.
The natural rate of unemployment is 3%.
The actual unemployment rate is 6%.
Suppose that the Fed suddenly and unexpectedly decreases the money supply in an effort to reduce inflation. As a result of this unanticipated action,
actual inflation falls to 3%.
On the previous graph, use the black point (plus symbol) to illustrate the short-run effects of this policy.
Now, suppose that-after a period of 3% inflation-households and firms begin to expect that the inflation rate will continue to be 3%.
On the previous graph, use the purple line (diamond symbol) to draw SRPC2, the short-run Phillips curve that is consistent with these expectations,
assuming that it is parallel to SRPC₁. Finally, use the orange point (square symbol) to indicate the new, long-run equilibrium for this economy.
The inflation rate at the new long-run equilibrium (point C) is
the unemployment rate at point A.
Was the Fed able to achieve its goal of lowering inflation?
the inflation rate at point A, and the unemployment rate at point C is
No, because the Fed cannot affect the inflation rate through monetary policy.
Yes, but only in the short run; in the long run, inflation returned to its natural rate.
Yes, the Fed's policy successfully reduced inflation in both the short run and the long run.
Now, suppose that the public fully anticipates the Fed's decision to decrease the money supply. Assume the public also believes that the Fed is firmly
committed to carrying out this policy. According to rational expectations theory, when the economy is in long-run equilibrium, a fully anticipated
decrease in the money supply will cause the economy to move
on the previous Phillips curve graph. In
this case, rational expectations theory predicts that the fully anticipated decrease in the money supply will have the immediate effect of
in the unemployment rate.
in the inflation rate and
Transcribed Image Text:INFLATION RATE (Percent)
1
2
5. Expectations and the Phillips curve
The following graph shows an economy in long-run equilibrium at point A (grey star symbol). The vertical line is the long-run Phillips curve (LRPC).
The downward-sloping curve labeled SRPC is the short-run Phillips curve passing through point A.
SRPC
LRPC
0
0
1
2
3
4
5
6
7
8
UNEMPLOYMENT RATE (Percent)
Which of the following is true along SRPC?
O The expected inflation rate is 5%.
The natural rate of unemployment is 3%.
The actual unemployment rate is 6%.
• } - *
SRPC2
ㄢ
C
(?)
Suppose that the Fed suddenly and unexpectedly decreases the money supply in an effort to reduce inflation. As a result of this unanticipated action,
actual inflation falls to 3%.
On the previous graph, use the black point (plus symbol) to illustrate the short-run effects of this policy.
Now, suppose that-after a period of 3% inflation-households and firms begin to expect that the inflation rate will continue to be 3%.
On the previous graph, use the purple line (diamond symbol) to draw SRPC2, the short-run Phillips curve that is consistent with these expectations,
assuming that it is parallel to SRPC. Finally, use the orange point (square symbol) to indicate the new, long-run equilibrium for this economy.
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