Figure 5.8: Tightening Monetary Policy to Address a Negative Supply Shock
Figure 5.8 illustrates how a central bank can address the policy dilemma created by a negative supply shock. By tightening monetary policy, the bank raises its policy interest rate sufficiently to increase the real interest rate. This action shifts the aggregate demand (AD) curve downward, as shown in the figure's bottom panel. The economy consequently moves to a new equilibrium at a lower level of output and employment (point C), which eliminates the inflationary bargaining gap and stabilizes inflation.
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Ch.5 Macroeconomic policy: Inflation and unemployment - The Economy 2.0 Macroeconomics @ CORE Econ
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Figure 5.8: Tightening Monetary Policy to Address a Negative Supply Shock
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Figure 5.8: Tightening Monetary Policy to Address a Negative Supply Shock
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