Start with a short-run Phillips curve (PC) showing 8% unemployment and 3% inflation. Now show with...

Start with a short-run Phillips curve (PC) showing 8% unemployment and 3% inflation. Now show with a diagram and describe what policy you would use to reduce unemployment to 5%. What is the outcome? Show the likely final result with another PC diagram. (4)

Expert Solution

This question is anwered with monetarist model.

As shown in the diagram below, current inflation is at 3% and unemployment at 8%. If unemployment has to come down to 5% theninflation should go up to say 5%.

This is possible when aggregate demad shifts right and average price levels go up from p1 to p2, real GDP goes up from Y1 to Y2, with more real GDP, more jobs are produced. Equlibrium shift from point a to b in AD-AS diagram will achieve desired result.This needs expansionary fiscal and monetary policy.

Fiscal policy is a policy controlled by the government and it has two tools: taxes and govt. spending. During recessions govt. decreases taxes and increases govt. spending which is called expansionary fiscal policy.

Monetary policy is a policy determined by central bank and has two tools; interest rates and money supply. When there is recession and central bank wants to boost economic activity then it decreases interest rates and increases money supply. This is called as expansionary monetary policy.

Rahul Sunny answered 6 months ago

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