21+Macroeconomic+Policy%2C+Part+2

21+Macroeconomic+Policy%2C+Part+2 - 1 21-1 Macroeconomic...

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Unformatted text preview: 1 21-1 Macroeconomic Policy and Aggregate Demand and Supply Analysis, Part 2 21-2 Agenda 1. Stabilizing Inflation and Economic Activity c. Short-run Supply Shocks 2. Issues in Stabilization Policy 3. Inflation: A Monetary Phenomenon 21-3 A Short-run Aggregate Supply Shock • Suppose: 1. The economy is initially in general equilibrium at the target inflation rate , and 2. There is then a temporary negative aggregate supply shock , and 3. The central bank has no policy response . 21-4 No Policy Response to a SRAS Shock Y π Y P AD π = π T LRAS SRAS ( π e = π ) 2 21-5 No Policy Response to a SRAS Shock π r π = π T r = r* MP 21-6 A Short-run Aggregate Supply Shock • Now suppose: 1. The economy is initially in general equilibrium at the target inflation rate , and 2. There is then a temporary negative aggregate supply shock , and 3. The central bank responds with a policy to stabilize inflation at π T in the short-run . 21-7 Policy Response to Stabilize Inflation Y π Y P AD π = π T LRAS SRAS ( π e = π ) 21-8 Policy Response to Stabilize Inflation π r π = π T r = r* MP 3 21-9 Policy Response to Stabilize Inflation • After a SRAS shock, a central bank monetary policy of stabilizing inflation leads to larger deviations of economic output from its potential level in the short-run. – Thus, there is a conflict between the dual objectives of stabilizing inflation and stabilizing economic activity. • And the divine coincidence does not hold. 21-10 Stabilizing Inflation and Economic Output • Conclusions: 1. If most shocks to the economy are aggregate demand shocks , then a monetary policy that stabilizes inflation will also stabilize economic output, even in the short-run. 2. If most shocks to the economy are permanent aggregate supply shocks , then a monetary policy that stabilized inflation will also stabilize economic output (at its new potential level), even in the short-run....
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This note was uploaded on 03/13/2012 for the course ECON 100B taught by Professor Wood during the Fall '08 term at Berkeley.

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21+Macroeconomic+Policy%2C+Part+2 - 1 21-1 Macroeconomic...

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