(Solved): 5. Expectations and the Phillips curve The following graph plots the fong-run Phillips curve (LRPC) ...

5. Expectations and the Phillips curve The following graph plots the fong-run Phillips curve (LRPC) and short-run Philips curve (SRPC \( \left.C_{1}\right) \) for an economy currently experiencing long-run equilibrium at point \( A \) (orey star symbol). Which of the followine is true along SRPC ? The actual infation rate is sos. The espected inflation rate is \( 5 \% \) The naturat tate of unemplovinent is \( 3 \% \). The actual unemployment rate is \( 6 \% \). uppose that the central bank for this economy suddenly and unexpectedly decreases the money supply in an effort to reduce inflation. As a result of his unanticipated policy action, actual infiation falis to \( 3 \% \). On the previous graph, use the black point (plus symbol labeled "B") to allustrate the short-runc effects of this policy. Suppose that now, after a period of \( 3 \% \) inflation, households and firms begin to expect that the inflation rate will persist at the level of \( 3 \% 5 \). On the previous graph, use the purpie line (diamond symbol) to draw SRPC2, the short-run Phillips curve that is consistent with these expectations, assuming that it is parailel to \( S R R P C_{1+} \) Finally, using the orange noint (square symbol labeled \( (C) \) ), indicate on the provious graph the new, fong - Cun equilibrium for this economy. The inflation rate at point \( C \) is unemployment nate at point \( A \). Was the central bank able to achieve its goal of lowering inflation? Yes, but only in the short run; in the long rin, intlation returned to its natural rate. No, because the central bank cannot affect the inflation rate through monetary polich. Yes, the central bank's policy successfully rediced inflation in both the stort run and the long run. Now, fuppose that the public fully aritidipates the cuntral bank's decision to decroase the monay supply. Assume the public also believes that the monetary auchority is firmily committid to carrying out this policy. Accordino to rational expectations theory, when the economv is in lann-run celilitrium, a fully anticiated decrease in the money supply will cause the economy to move