Our monetary model consists of three equations, the Interest-Savings equation, the (Short Run) Phillips Curve, and an Interest Rate Rule,
y=A-r
pie=pie^e +k (y-y*)
r=r*+Øy(y-y*) +Øpie (pie-pie^t)
where output, 'efficient' output, real interest rate, real interest rate associated with 'efficient' output, inflation, expected inflation, target inflation.
Assume the economy starts in long-run equilibrium.
a) Draw a graph showing how the equilibrium changes in the short-run when there is an decrease in . (Assume there is no other change. )