5. 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 decrease 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-runeffects of this policy.

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

SR Phillips CurvePoint along PC03691215186543210INFLATION RATE (Percent)UNEMPLOYMENT RATE (Percent)SR Phillips Curve

In the short run, an unexpected decrease in the money supply results in in the inflation rate and 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-runeffects of the decrease in the money supply.

SR Phillips CurvePoint along PC03691215186543210INFLATION RATE (Percent)UNEMPLOYMENT RATE (Percent)SR Phillips Curve

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