assume that an economy starts at along-run equilibrium with a natural rate of un

Question

assume that an economy starts at along-run equilibrium with a natural rate of unemployment equal to 6 percent and an inflation rate of 10 percent. assume that there is a short-run tradeoff between inflation and unemployment as described by a phillips curve. use the phillips curve to graphically illustrate why a central bank that desires both low inflation and low unemployment has the incentive to renege on an announced policy to reduce inflation to 3 percent, if people set wages and prices on the expectation of 3 percent inflation and the central bank has the discretion to change its monetary policy after these expectations are set.

Explanation / Answer

The central bank will perform the monetary policy by raising fund rate to curb inflation.Money supply will decrease. The government will perform the fiscal policy by financing the budget deficits through borrowing. The increase spending will create employments.The borrowing will raise the interest rate even more due to the crowding-out effects. Together, it will increase employment,lower unemployment, and lower inflation

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