Suppose an economy is subject to the following Phillips curve: =E 0.6(0.05) Where, E = .04 is the current inflation expectation.

a) Draw the figure of short-run and long-run relationships between inflation and unemployment of the above Philips curve. (3 points)

b) Suppose the central bank reduces the inflation rate by 1 percentage point. How does that affect the unemployment rate in the short run and in the long run, in the following two cases:

b1). Households fully anticipate the reduction of inflation (3 points)

b2). Households don't anticipate the reduction of inflation. (3 points)

c) Now, assume that the Philips Curve is equal to =0.6(0.05), where 1 = 0.04 is the inflation rate of the last year. Considering the Lucas critique, should policymakers use this Philips Curve for making policy? Why? (3 points)