1 The Phillips Curve 1.1 (Q3) Overstimulating the economy Suppose the economy today is producing output at its potential level and the inflation rate is equal to its long-run level, with = 2%. Consider the two scenarios described by the Phillips curves in the figure below. What happens if policymakers try to stimulate the economy to keep output above potential by 3% every year? How does your answer depend on the slope of the Phillips curve? Change in inflation, AT Phillips curve (slope > 1) Phillips curve (slope = 1) > 0 0 0 +3% Short-run output, Complete the following table. Inflation, T Inflation, T 0 Year Phillips curve (slope = 1) 2% Phillips curve (slope = 1.5) 2% 123456 1.2 (Q5) An oil shock Consider an economy that begins with output at its potential level and a relatively high inflation rate of 6%, reflecting some recent oil price shocks. Suppose that there exists a menu of policy choices that let you pick a sequence of short-run output levels that will get the rate of inflation back down to 3% no later than 3 years from now. Short-run output -Inflation- Option Year 1 Year 2 Year 3 Year 1 Year 2 Year 3 1 -6% 0 0 3% 3% 3% 2 -4% -2% 0 4% 3% 3% 3 -2% -2% -2% 5% 4% 3% According to these numbers, what is the slope of the Phillips curve?