Can the Federal Reserve achieve both low inflation and low levels of unemployment? Explain

What will be an ideal response?

To reduce inflation, the Federal Reserve must reduce the money supply, which results in higher interest rates. When interest rates increase, consumption and firm investment fall, resulting in a decrease in aggregate demand and, as the short-run Phillips curve shows, an increase in the level of unemployment in the short run. This result indicates that the Fed cannot simultaneously reduce inflation and unemployment. However, if people immediately revise their inflation expectations once the Fed announces a change in monetary policy, the announcement on contraction in the money supply will move the economy down its long-run Phillips curve to a lower rate of inflation with no change in the unemployment rate. In that case, it would be possible to reduce inflation with no increase in unemployment.