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

A negative supply shock causes both inflation and a decline in potential output. Therefore, policymakers need to raise the real interest rate by even more than they would in the case of a recessionary gap to cool down inflationary pressures and stabilize the economy.

If a Negative Supply Shock Is Associated with a Decline