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 sharp increases in oil prices or a natural disaster reducing production capacity can lead to both higher inflation and lower output. Policymakers face a trade-off because they cannot simultaneously stabilize both output and inflation. They may focus on stabilizing output, but this can lead to higher inflation, or they may focus on stabilizing inflation, but this can lead to a further decline in output. The best policymakers can do is to choose a policy response that balances the trade-offs between maintaining stable inflation and output levels.

When Faced with Negative Supply Shocks, Policymakers