4. Monetary policy and the Phillips curve The following graph shows the current

Question

4. Monetary policy and the Phillips curve

The following graph shows the current short-run Phillips curve for a hypothetical economy; the point on the graph shows the initial unemployment rate and inflation rate. Assume that the economy is currently in long-run equilibrium.

Suppose the central bank of the hypothetical economy decides to increase the money supply.

On the following graph, shift the curve or drag the blue point along the curve, or do both, to show the short-run effects of this policy.

Hint: You may assume that the central bank's move was unanticipated.

In the short run, an unexpected increase in the money supply results in (Decrase / Increase / No Change) in the inflation rate and (Decrease / Increase / No Change) in the unemployment rate.

On the following graph, shift the curve or drag the blue point along the curve, or do both, to show the long-run effects of the increase in the money supply.

In the long run, the increase in the money supply results in (No Change / Decrease / Increase) in the inflation rate and (Decrease / No Change / Increase) in the unemployment rate (relative to the economy's initial equilibrium).

Explanation / Answer

In the short run, an unexpected increase in the money supply results in ( Increase ) in the inflation rate and (no change ) in the unemployment rate . The Phillips curve shifts right . At same level of unemployment the level of inflation rises . In the short run , more production can not be done suddenly so just inflation rises .

In the long run, the increase in the money supply results in ( Increase) in the inflation rate and (Decrease ) in the unemployment rate (relative to the economy's initial equilibrium) .

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