Consider a Hypothetical Economy in Which Policy Makers Have Never

Essay

Consider a hypothetical economy in which policy makers have never used inflation to try to stimulate the economy.Let's say that inflation is 0 percent and market participants expect 0 percent inflation going forward.In addition,the natural rate of unemployment is 6 percent.
a.Draw a diagram representing the short- and long-run Phillips curves with expected inflation and actual inflation on the y axis and the unemployment rate on the x axis.
b.Show what happens in the short run if the central bank of this economy decides to enact policy that raises the inflation rate to 3 percent.
c.Because the inflation rate is 3 percent,market participants expect a 3 percent inflation rate.Show what impact this has on the short-run Phillips curve.
d.Discuss how this demonstrates the long-run Phillips curve.