Question

Explain the actions the FED should take if it wanted to move from a point on the short-run Phillips curve representing high unemployment and low inflation to a point representing lower unemployment and higher inflation.

Answer 1

The Phillips curve states that inflation and unemployment have an inverse relationship.Higher inflation is associated with lower unemployment and vice versa.

Below are the steps FED can take to move the curve on a point representing lower unemployment and higher inflation.

Expansionary Monetary Policy:- During this policy FED changes monetary policy by reducing the federal fund rate, this reduces the overall interest rate which encourages the businesses to buy more capital, equipments and hire more workers.As a result of these factors household wealth increases.

This policy also influence the inflation. When the fund rates are reduced this results in the stronger demand of goods and services which pushes the wages to go higher, reflecting the greater demand for worker and materials necessary for production.This economic activities increases the expectations for future that how the economy will perform, these expectations directly influence the inflation to go up.

Fiscal Policy:- The second way is through fiscal policy by cutting the taxes, this will give people more income to spend.This stimuletes spending just like reducing the interest rates.

Conclusion:- Phillips curve relation between unemployment and inflation may not hold in the long run or even in short run in some cases.we have seen in stagnant economic growth where unemployment and inflation both were high in between 1973 and 1975.