In the top graph that follows, equilibrium initially occurs where the MP1 curve intersects the IS curve. The real interest rate equals r1 and the output gap equals zero. In the bottom graph, equilibrium initially occurs where the PC1 curve intersects the line where the output gap equals zero. The inflation rate equals -2%. Explain what happens when FED lowers the real interest rate from r1 to r2 with the output gap, expected inflation and long-run equilibirium.

Y = Y Real interest rate, r MP 1 MP IS 0 Output gap, Y Y . Y' Inflation PC rate, 7 PC, 2% Output gap, Y -2%