An economy experiences a sudden, persistent negative supply-side event that raises production costs for all firms. This causes inflation to rise and establishes a new, higher rate of unemployment at which inflation would be stable. Given this new economic reality, which of the following policy responses is most likely to succeed in bringing inflation back down to the central bank's original target?

Policy Response to a Supply Shock

The Necessity of Policy Intervention After a Supply Shock

Following a permanent adverse supply-side event that increases the equilibrium unemployment rate, an economy will automatically return to its initial inflation target as long as policymakers do not interfere with the adjustment process.

The Role of Policy in Economic Adjustment

An economy is hit by a permanent adverse event that raises the cost of production for all firms. Arrange the following events to show the typical sequence of how policymakers would guide the economy back to a low and stable rate of price increases.

Following a persistent adverse supply-side event that has pushed up inflation, policymakers must take deliberate actions to guide the economy back to its inflation target. Match each policy action with its primary intended effect in this disinflationary process.

An economy experiences a permanent adverse supply-side event, leading to a higher stable-inflation rate of unemployment and a surge in price increases. A policymaker argues against intervention, believing the economy will naturally return to the original low inflation target on its own. Which of the following outcomes is the most likely consequence of this policy of inaction?

An economy experiences a permanent adverse supply-side event that raises both inflation and the unemployment rate at which inflation is stable. A policymaker proposes, 'To combat this inflation, our primary goal should be to use economic stimulus to quickly reduce unemployment back to its original, pre-event level.' Which of the following best evaluates the likely outcome of this proposed policy?

Following a persistent adverse supply-side event, a central bank deliberately tightens its policy stance, causing unemployment to rise temporarily above the new, higher rate at which inflation would be stable. This policy-induced economic slowdown is designed to create a __________ in the labor market, which is the necessary mechanism to put downward pressure on wage and price inflation.