Question: In 1999 and early 2000, the Fed increased the target federal funds rate repeatedly, in part because it believed that the economy was overheating and

In 1999 and early 2000, the Fed increased the target federal funds rate repeatedly, in part because it believed that the economy was overheating and that inflation would rise. The graph below shows the position of the economy prior to the Fed€™s actions.

a. Explain how the Fed€™s actions would be expected to affect the economy, being careful to explain all the steps.
b. Show the effect of the Fed€™s actions on the IS€“MP graph and then relate your answer to the Phillips curve.

MP IS Output gap,Y (percent deviation from potential GDP)

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