# The monetary policy curve indicates relationship between critical thinking

### The Phillips curve in the Keynesian perspective (article) | Khan Academy

The Phillips Curve shows a clear negative relationship between the unemployment rate and the inflation rate Fiscal and monetary policy could be used to move up or down the Phillips curve as desired. Then a Thus, you can think of Keynesian economics as pursuing a “Goldilocks” level of Critical Thinking Questions. Read about how we can use the Keynesian perspective to think about the common tradeoff between low A Phillips curve shows the tradeoff between unemployment and inflation in an economy. Fiscal and monetary policy could be used to move up or down the Phillips curve as desired. . Critical-thinking question. This graph shows how monetary policy shifts the supply of loanable funds. of loanable funds to the left from the original supply curve (S0) to the new supply (S 2), and raise the interest rate from 8% to 10%. .. Critical Thinking Questions.

Although generally accepted as being imperfect, the model is seen as a useful pedagogical tool for imparting an understanding of the questions that macroeconomists today attempt to answer through more nuanced approaches.

As such, it is included in most undergraduate macroeconomics textbooks, but omitted from most graduate texts due to the current dominance of real business cycle and new Keynesian theories. The horizontal axis represents national income or real gross domestic product and is labelled Y. The vertical axis represents the real interest rater. Since this is a non-dynamic model, there is a fixed relationship between the nominal interest rate and the real interest rate the former equals the latter plus the expected inflation rate which is exogenous in the short run ; therefore variables such as money demand which actually depend on the nominal interest rate can equivalently be expressed as depending on the real interest rate.

The point where these schedules intersect represents a short-run equilibrium in the real and monetary sectors though not necessarily in other sectors, such as labor markets: This equilibrium yields a unique combination of the interest rate and real GDP.

## Monetary policy

IS curve[ edit ] IS curve represented by equilibrium in the market for loanable funds and Keynesian cross diagram. The Keynesian zone is farthest to the left as well as the lowest; the intermediate zone is the center of the three curves; the neoclassical is farthest to the right as well as the highest. A nation could choose low inflation and high unemployment, or high inflation and low unemployment, or anywhere in between. Fiscal and monetary policy could be used to move up or down the Phillips curve as desired.

Then a curious thing happened. When policymakers tried to exploit the tradeoff between inflation and unemployment, the result was an increase in both inflation and unemployment. The Phillips curve shifted. The US economy experienced this pattern in the deep recession from to and again in back-to-back recessions from to Many nations around the world saw similar increases in unemployment and inflation.

This pattern became known as stagflation—an unhealthy combination of high unemployment and high inflation.

### Fiscal and Monetary Policies and IS-LM Curve Model

Perhaps most important, stagflation was a phenomenon that could not be explained by traditional Keynesian economics. Economists have concluded that two factors cause the Phillips curve to shift. The latter regimes would have to implement an exchange rate target to influence their inflation, as none of the other instruments are available to them.

Credibility[ edit ] The short-term effects of monetary policy can be influenced by the degree to which announcements of new policy are deemed credible. But if the policy announcement is deemed credible, inflationary expectations will drop commensurately with the announced policy intent, and inflation is likely to come down more quickly and without so much of a cost in terms of unemployment.

Y1/IB 31) Monetary Policy (Interest Rates, Money Supply and Exchange Rate)

Thus there can be an advantage to having the central bank be independent of the political authority, to shield it from the prospect of political pressure to reverse the direction of the policy. But even with a seemingly independent central bank, a central bank whose hands are not tied to the anti-inflation policy might be deemed as not fully credible; in this case there is an advantage to be had by the central bank being in some way bound to follow through on its policy pronouncements, lending it credibility.

Contexts[ edit ] In international economics[ edit ] Optimal monetary policy in international economics is concerned with the question of how monetary policy should be conducted in interdependent open economies.

The classical view holds that international macroeconomic interdependence is only relevant if it affects domestic output gaps and inflation, and monetary policy prescriptions can abstract from openness without harm. The policy trade-offs specific to this international perspective are threefold: Second, another specificity of international optimal monetary policy is the issue of strategic interactions and competitive devaluations, which is due to cross-border spillovers in quantities and prices.

Even though the gains of international policy coordination might be small, such gains may become very relevant if balanced against incentives for international noncooperation. Even though the real exchange rate absorbs shocks in current and expected fundamentals, its adjustment does not necessarily result in a desirable allocation and may even exacerbate the misallocation of consumption and employment at both the domestic and global level.

This is because, relative to the case of complete markets, both the Phillips curve and the loss function include a welfare-relevant measure of cross-country imbalances. Consequently, this results in domestic goals, e. In developing countries[ edit ] Developing countries may have problems establishing an effective operating monetary policy.

The primary difficulty is that few developing countries have deep markets in government debt. The matter is further complicated by the difficulties in forecasting money demand and fiscal pressure to levy the inflation tax by expanding the base rapidly.