If the unemployment rate in the economy is steady at 4 percent per year, how does the short-run Phillips curve predict that the inflation rate will be changing, if at all? What will happen if the unemployment rate now rises to 7 percent per year?
Assume there are no changes to inflation expectations. Provide an appropriate graph to support your discussion.
If the unemployment rate is constant at 4 percent per year, the inflation rate should remain constant, as shown in the graph below (as long as the unemployment rate is 4 percent, the inflation rate does not change). If the unemployment rate rises to 7 percent, then the Phillips curve would predict that the inflation rate will be lower than it was when unemployment was 4 percent.
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