When faced with negative supply shocks, policymakers:
A) will stabilize both inflation and output.
B) will always focus on stabilizing output.
C) cannot stabilize output so they tend to focus on inflation.
D) face a trade-off because they cannot simultaneously stabilize both output and inflation.

Question

Quizplus · Accepted Answer

Negative supply shocks, such as an increase in oil prices, lead to a decrease in output and an increase in inflation. Policymakers face a trade-off because they cannot simultaneously stabilize both output and inflation. If they focus on stabilizing output by increasing government spending or cutting interest rates, it may lead to higher inflation. On the other hand, if they focus on reducing inflation by tightening monetary policy or reducing government spending, it may lead to a further decrease in output. Therefore, policymakers have to choose a balanced approach that considers both output and inflation.

When Faced with Negative Supply Shocks, Policymakers