If a negative supply shock is associated with a decline in potential output, policymakers need to:
A)raise the real interest rate by even less than they would in the case of a recessionary gap.
B)raise the real interest rate by even more than they would in the case of a recessionary gap.
C)raise the real interest rate by the same amount as they would in the case of a recessionary gap.
D)not shift the monetary policy reaction curve.

Question

Quizplus · Accepted Answer

When there is a negative supply shock, it results in a decline in potential output, which causes prices to increase. In such a situation, policymakers need to raise the real interest rate by even more than they would in the case of a recessionary gap. This is because the increase in interest rates would dampen demand and reduce inflationary pressures caused by the negative supply shock.

If a Negative Supply Shock Is Associated with a Decline