Consider an economy with ongoing inflation with backward-looking expectations, ItE(t) = Tt(t-1), where ItE(1) is the expected inflation rate at time t and Tt(t-1) is actual inflation at time t-1. The augmented Phillips curve PC(t) written in terms of output gaps is Tt(t) = =(1) + a (y(t) - ye ) where a > 0 is a constant, y(t) is outputat time t, and ye is potential output. The economy at time t = 0 is in point A in the figure below: inflation is to) and output is equal to y(0), strictly below potential output. The Central Bank knows the Phillips curve and is able to decide output in all future periods (t = 1,2,...). It (1) PC(0) A It(O) y(t) y(0) ye The Central Bank would like to induce an inflation rate it in the medium run and considers two alternative strategies: Strategy I. Keep output at the initial level y(o) until inflation reaches IT and stabilize the economy from that point onwards. Strategy II. Induce a series of gradual increases in output until inflation reaches it and output is stabilized