The following figure depicts the Phillips curve and the indifference curves of an eco- nomy. This economy has an independent central bank with an inflation target of 2%. Consider an aggregate demand shock that increases unemployment. Explain why the central bank would cut the interest rate to put upward pressure on inflation, in order to bring it back to the target rate.
The following figure depicts the Phillips curve and the indifference curves of an eco- nomy. This economy has an independent central bank with an inflation target of 2%. Consider an aggregate demand shock that increases unemployment. Explain why the central bank would cut the interest rate to put upward pressure on inflation, in order to bring it back to the target rate.
Principles of Economics (MindTap Course List)
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Author:N. Gregory Mankiw
Publisher:N. Gregory Mankiw
Chapter35: The Short-Run Trade-off Between Inflation And Unemployment
Section: Chapter Questions
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![The following figure depicts the Phillips curve and the indifference curves of an eco-
nomy. This economy has an independent central bank with an inflation target of 2%.
Consider an aggregate demand shock that increases unemployment.
Explain why the central bank would cut the interest rate to put upward pressure on
inflation, in order to bring it back to the target rate.
Labour supply
Central bank's
indifference curves
Phillips curves
Inflation 2
Inflation-targeting central bank's
best outcome: target inflation and
the inflation-stabilizing
unemployment rate
target
Employment, N
U-6%
Employment at labour market equilibrium,
inflation-stabilizing unemployment rate
Inflation, 7 (%)](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F9b2bfce8-dbce-4dc0-8f1d-345361e6e3ca%2F32b63bc5-2617-4999-8907-153dd5a51579%2Fgu19cau_processed.jpeg&w=3840&q=75)
Transcribed Image Text:The following figure depicts the Phillips curve and the indifference curves of an eco-
nomy. This economy has an independent central bank with an inflation target of 2%.
Consider an aggregate demand shock that increases unemployment.
Explain why the central bank would cut the interest rate to put upward pressure on
inflation, in order to bring it back to the target rate.
Labour supply
Central bank's
indifference curves
Phillips curves
Inflation 2
Inflation-targeting central bank's
best outcome: target inflation and
the inflation-stabilizing
unemployment rate
target
Employment, N
U-6%
Employment at labour market equilibrium,
inflation-stabilizing unemployment rate
Inflation, 7 (%)
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