The two paths to the medium-run equilibrium explored in this chapter make two different assumptions about the formation of the level of expected inflation. One path assumes the level of expected inflation equals lagged inflation. The level of expected inflation changes over time. The other path assumes the level of expected inflation is anchored to a specific value and never changes. Begin in medium-run equilibrium where actual and expected inflation equals 2% in period.

Suppose there is an increase in consumer confidence in period t + 1. How does this impact the IS-LM graph?

How will the short-run equilibrium in period t + 1 compare to the equilibrium in period t?

Real interest rate, r Output, Y -LM IS