Question

2. A well-known economic model called the Phillips Curve (in The Keynesian Perspective) describes the short run tradeoff typically observed between inflation and unemployment. Based on the discussion of expansionary and contractionary monetary policy, explain why one of these variables usually falls when the other rises. (1.5 Marks)

Answer 1

First lets suppose that the inflation is high and the fed uses Contractionary monetary policy then in this case the fed will want to lower the money supply which decreases aggregate expenditure in the economy that is consumption,investment,government expenditure falls which will lower the inflation and prices will come down but also increase the unemployment as when the demand decreases,the firms would want to produce less and employ less labor so the inflation decreases but the unemployment increases.

Second,lets suppose that the recession is high and the fed uses Expansionary monetary policy then in this case the fed would want to increase the aggregate demand by increasing the money supply which will increase the consumption,investment and government expenditure in the economy so aggregate expenditure rises and as the demand for goods increases,the firms would want to hire more labor to produce more output so the inflation increases but the unemployment decreases.