Imagine that the central bank has dual mandate. Suppose that a temporary negative supply shock hits...

Imagine that the central bank has dual mandate. Suppose that a temporary negative supply shock hits the economy.

What is an example of a temporary negative supply shock? (1 mark)
If the central bank does nothing, what happens to output and inflation in both the short run and the long run? Illustrate using a diagram.

c) What is the difficult choice faced by the central bank when there is a temporary negative supply shock? (1 mark)

d) If the central bank cares slightly more about stabilizing output than about controlling inflation, what would the central bank do in this situation? Illustrate using a diagram.

e) After the central bank’s action in part (e), what is likely to happen to inflation in the long-run?

Expert Solution

Rahul Sunny answered 1 year ago

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