Figure 5.13: An Inflationary Supply Shock
Figure 5.13 illustrates the complex consequences of a persistent negative supply shock. The diagram shows that such a shock leads to a new, higher inflation-stabilizing unemployment rate (). It also depicts the immediate dilemma of stagflation, where the economy faces both rising inflation and increased unemployment. Furthermore, the figure demonstrates that if inflation expectations become unanchored and rise, the Phillips curve shifts upward. In this scenario, even a monetary policy that successfully guides the economy to the new supply-side equilibrium will fail to bring inflation back to its target.
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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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Figure 5.13: An Inflationary Supply Shock
The Necessity of a Costly Recession to Counter Unanchored Expectations After a Supply Shock
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An economy experiences a sudden, sharp increase in the price of all imported raw materials, leading to higher production costs for most businesses. In response, the central bank announces it will prioritize maintaining the current level of employment and will avoid any immediate actions that might slow down the economy. Based on this policy choice, what is the most significant risk the central bank is accepting?
Evaluating a Central Bank's Policy Response to a Supply Shock
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