If the Federal Reserve wants to reduce inflation from 4 percent to 3 percent permanently, how can that goal be achieved, and what impact will that have on employment in the short run and the long run? Support your answer with a graph of the Phillips

curve in the short run and the long run.

If the Fed wants to reduce inflation, it must implement a contractionary monetary policy and make it credible. The reduction in the growth rate of the money supply will increase interest rates, reduce aggregate demand, and reduce real GDP and employment in the short run. In terms of the short-run Phillips curve, the economy will move from a point like A (high inflation and low unemployment) to a point like B (lower inflation and higher unemployment). Once firms and workers believe the Fed will continue to follow a contractionary monetary policy, they will begin to reduce their inflation expectations, and the short-run Phillips curve will shift downward. Equilibrium in the economy will be restored at the natural rate of unemployment but at a lower rate of inflation (move from point B on the short-run Phillips curve to point C on the long-run Phillips curve).