Credible Inflation Target
The question
Assume the economy of Marren is operating at its natural rate of unemployment with stable inflation. The central bank of Marren announces and credibly commits to a much lower inflation target, and workers and firms respond by lowering the rate of inflation they expect in the future. Assume the structural and frictional determinants of the natural rate are unchanged. Show the short-run effect of this change in the Phillips curve model. Show the effect on the Phillips Curve graph.
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Credible Inflation Target: the worked answer
On the Phillips Curve graph, SRPC shifts down (left).
Why SRPC shifts down (left)
When expected inflation falls, workers negotiate smaller nominal wage increases, which lowers production costs for firms at every level of unemployment. This means the actual inflation rate at any given unemployment rate is now lower, so the short-run Phillips curve shifts down and to the left. The natural rate of unemployment is determined by structural and frictional factors, which are held constant, so the long-run Phillips curve does not move.
What happens to the equilibrium
At the natural rate of unemployment the economy now experiences a lower inflation rate, so every short-run unemployment-inflation combination carries less inflation than before.
The mistake students make on this one
The usual error is to shift the LRPC left, treating a credible central bank as something that permanently buys lower unemployment. Credibility changes only the inflation rate people build into wages and prices; it does not change the frictional and structural forces that set the natural rate.
On exam day
Lower expected inflation moves the SRPC down and to the left. Graders almost always want the sentence 'the LRPC does not shift' as well, so write it out explicitly rather than leaving it implied by your drawing.
How this is graded
The checker reads every curve's position before and after your answer. You are marked correct only when SRPC shifts down (left) and every other curve on the Phillips Curve graph stays where it started — the same standard an AP reader applies to a drawn graph: the right shift, and nothing extra. There is no AI involved; the rubric is the geometry.
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