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Question - Imagine that the central bank has a dual mandate. Suppose that a temporary negative supply shock hits the economy
(a) If the central bank does nothing, what happens to output and inflation in both the short run and the long run? Illustrate using a diagram.
(b) What is the difficult choice faced by the central bank when there is a temporary negative supply shock?
(c) If the central bank cares slightly more about stabilising output than about stabilising inflation, what would the central bank do in this situation? Illustrate using a diagram.
(d) After the central bank's action in part (c), what are the long-run effects on inflation and output likely to be?
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