Question 3

3. The long-run effects of monetary policy The following graphs plot the long-run equilibrium situation for an economy. The first graph plots the aggregate demand (AD) and long-run aggregate supply (LRAS) curves. The second graph plots the long-run and short-run Phillips curves (LRPC and SRPC, respectively). LRAS O AD O LRAS PRICE LEVEL AD 3 9 12 15 18 OUTPUT (Trillions of dollars)(?) LRPC SRPC LRPC INFLATION RATE SRPC 6 10 12 UNEMPLOYMENT RATE (Percent) Which of the following statements are true based on these graphs? Check all that apply. The natural level of output is 6%. O The natural rate of unemployment is 6%. It is impossible to determine the natural rate of unemployment from these graphs alone. Suppose the central bank of the economy pursues a policy that decreases the money supply. Show the long-run effects of this policy on both of the graphs by shifting the appropriate curves. The long-run effect of the central bank's policy is in the inflation rate, in the unemployment rate, and in real GDP. Grade It Now Save & Continue4. Monetary policy and the Phillips curve The following graph plots the short-run Phillips curve for a hypothetical economy. The given point on the graph indicates the initial rates of unemployment and inflation. Assume that the economy is currently in long-run equilibrium. Suppose the central bank of the hypothetical economy decides to increase the money supply. On the following graph, shift the curve or drag the blue point along the curve, or do both, ta show the short-run effects of this policy. Hint: You may assume that the central bank's move was unanticipated. @ & O 5 SR Phillips Curve = O c 2 4 T L = 43 o = o 1 T 1 = i = 1 . I SR Phillips Curve 1T 1 1 1 a t t ' t t 0 2 4 8 8 i 12 UNEMPLOYMENT RATE (Percent) In the short run, an unexpected increase in the money supply results in w in the inflation rate and W 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 leng-run effects of the increase in the money supply. @ 8 O &8 - o c 2 4 T L g 43 = = S I = 3 . g ' I = 1 1 1 1 1 1 0 l 0 2 4 & 8 10 12 UNEMPLOYMENT RATE (Percent) In the long run, the increase in the money supply results in W _in the inflation rate and W in the unemployment rate {relative to the economy's initial equilibrium})