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Inflation 0 output y ad sras lras y alternative use

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Inflation ( ) 0 Output ( Y ) AD SRAS LRAS Y* Alternative use expansionary fiscal or monetary policy to increase aggregate demand SRAS’ Y Short run equilibrium AD’ Long run equilibrium with stabilisation policies
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60 3. Using the AS-AD model: There is severe drought which permanently reduces production of fresh and processed fruit . Inflation ( ) 0 Output ( Y ) AD (aggregate demand) SRAS (short run aggregate supply) LRAS (long run aggregate supply) Y* What happens to the economy in the short run? the long run? Should the government use stabilisation policies (other than RBA policy reaction function) to close the output gap? Consider the costs and benefits.
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61 3. Using the AS-AD model: There is severe drought which permanently reduces production of fresh and processed fruit . Inflation ( ) 0 Output ( Y ) AD ( SRAS LRAS Y* Y*’ LRAS’ Short run equilibrium
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62 3. Using the AS-AD model: There is severe drought which permanently reduces production of fresh and processed fruit . Inflation ( ) 0 Output ( Y ) AD (aggregate demand) SRAS LRAS (long run aggregate supply) Y* New long run equilibrium Y*’ SRAS’
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Whether to use macroeconomic policies (ie stabilisation policies) Consider costs vs benefits Inflation, deflation Output gap, unemployment Speed of adjustment Policies which enhance adjustment labour market flexibility Role of inflation targeting 63
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4. Controlling inflation contractionary monetary policy . 64 Inflation ( ) 0 Output ( Y ) AD LRAS Y* SRAS Initial full employment output but high inflation. Could use contractionary stabilisation policies to create a recessionary gap
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4. Controlling inflation contractionary monetary policy . 65 Inflation ( ) 0 Output ( Y ) AD LRAS Y* SRAS
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4. Controlling inflation contractionary monetary policy . 66 Inflation ( ) 0 Output ( Y ) AD LRAS Y* SRAS
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67 4. Controlling inflation inflation targeting . Inflation ( ) 0 Output ( Y ) AD LRAS Y* SRAS Initial full employment output but expansionary gap opens up. RBA start to increase r before inflation starts to rise shift in RBA policy function AD’
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RBA approach to controlling inflation 1989 contractionary monetary policy ongoing increases in interest rates led to recession high cost to growth and unemployment Since early 1990s inflation targeting RBA announces inflation target - RBA maintains credibility by continually publicising its inflation targets, achieving them, and operating at ‘arms length’ from government/politicians 68
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70 Unit 8 Key Points Aggregate demand (AD) & RBA policy reaction function Short run aggregate supply (SRAS), long run aggregate supply (LRAS) and inflation The Aggregate Supply-Aggregate Demand Model Self correction …. or not???? Sources of inflation RBA and anti inflationary policies
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