Eliminating the Bargaining Gap by Reducing Aggregate Demand
To fulfill an inflation-targeting mandate after a negative supply shock, a central bank must eliminate the positive bargaining gap that is driving inflation. The necessary course of action is to reduce aggregate demand. This reduction in demand leads to a fall in output and employment, moving the economy to its new, lower supply-side equilibrium, thereby closing the bargaining gap and stabilizing inflation.
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Introduction to Macroeconomics Course
Ch.5 Macroeconomic policy: Inflation and unemployment - The Economy 2.0 Macroeconomics @ CORE Econ
The Economy 2.0 Macroeconomics @ CORE Econ
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Eliminating the Bargaining Gap by Reducing Aggregate Demand
Increased Cost of Disinflation Due to a Delayed Policy Response to a Supply Shock
An economy is experiencing stable, low inflation and low unemployment. Suddenly, a global event causes a sharp and persistent increase in the cost of imported raw materials. In the immediate aftermath, inflation begins to rise while employment remains at its initial level. Which statement best analyzes the primary challenge this situation presents for the central bank whose main objective is to maintain price stability?
Central Bank Policy Dilemma After an Economic Shock
The Central Bank's Policy Trade-off
An economy, initially in a state of equilibrium, is hit by a negative supply shock (e.g., a sudden, large increase in oil prices). Arrange the following events in the logical order that demonstrates the trade-off an inflation-targeting central bank must confront.
Central Bank's Policy Dilemma
Learn After
Figure 5.8: Tightening Monetary Policy to Address a Negative Supply Shock
Central Bank Policy Response to a Supply Shock
An economy experiences a severe and persistent increase in the cost of raw materials, leading to a rise in the general price level above the central bank's target. To fulfill its mandate of stabilizing prices, what is the necessary course of action for the central bank, and what is the direct consequence of this action?
An economy is in equilibrium with stable inflation at the central bank's target. It then experiences a permanent negative supply-side shock (e.g., a lasting increase in the price of oil). Arrange the following events in the logical sequence that describes how the central bank would successfully return inflation to its target.
Evaluating Policy Responses to Supply-Side Inflation