1. Contractionary Monetary Policy
In the Long-run - The Phillips Curve Shifts Downward
Inflation
Rate
Unemployment
As the Fed moves the economy to point F and keeps it there for some time, the public will eventually come to expect 3% inflation in the future.
The built-in expected inflation rate will fall and the Phillips curve will shift downward to PCexpected inflation = 3%.
The economy will move to point G in the long run, with unemployment at the natural rate and an actual inflation rate equal to the expected rate of 3%
Pcexpected inflation
= 6% E 6%
Pcexpected inflation
= 3% UN G F 3% U1

2. Expansionary Monetary Policy The Phillips Curve Shifts Upward
Initially, the economy is at point E, with inflation equal to the built-in rate of 6%. If the Fed moves the economy to point H and keeps it there for some time, the public will eventually come to expect 9% inflation in the future.
The expected inflation rate will rise and the Phillips curve will shift upward to PCexpected inflation = 9%. The economy will move to point J in the long run, with unemployment at the natural rate and an actual inflation rate equal to the built-in rate of 9%.
Inflation
Rate
Unemployment
Pcexpected inflation
= 9%
Pcexpected inflation
= 6% H J 9% U2 E 6% UN

3. Expectations and Ongoing Inflation
In the Long run there is no tradeoff
Unemployment always returns to its natural rate
Long-run Phillips curve
A vertical line
In the long run, unemployment must equal its natural rate
Regardless of the rate of inflation

4. Long-Run Phillips Curve
The Long-Run Phillips Curve
Inflation
Rate
Unemployment
PCexpected inflation
= 9%
Long-Run Phillips Curve
Starting at point E with 6% inflation, the Fed can choose unemployment at the natural rate with either a higher rate of inflation (point J ) or a lower rate of inflation (point G ). But points off of the vertical line are not sustainable in the long run.
PCexpected inflation
= 6% H J 9%
PCexpected inflation
= 3% U2 E 6% UN G F 3% U1