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A comprehensive understanding of how an economy can reduce inflation (disinflation), particularly after a supply-side event like an oil shock, requires an analysis of the role played by policymakers and their interventions.

The Role of Policymakers in Managing Disinflation After a Supply Shock

The Phillips curve model helps to explain the economic strategy used to combat high inflation following the oil shocks of the 1970s. In this historical instance, policymakers induced a period of high unemployment to create a negative bargaining gap, which was instrumental in bringing the persistent inflation rates down.

Using High Unemployment to Reduce Inflation After the 1970s Oil Shocks

Imagine you are an advisor to a central bank. A sudden, unexpected global event has drastically increased the cost of a key raw material used by nearly every industry in your country. As a result, businesses are raising their prices, and economic activity is slowing down, leading to job losses. The central bank must decide how to react. 

Critique the two main opposing policy paths the central bank could take in response to this event. In your critique, you must: 
1. Describe each policy path. 
2. Analyze the likely immediate consequences of each path for both the price level and the unemployment rate. 
3. Justify which path would be more effective for achieving long-term price stability, even if it comes with significant short-term costs.

Policymaker's Dilemma After an Economic Shock

Imagine an economy is hit by a severe negative supply shock, causing both a rise in the general price level and a decrease in output. A central bank must decide how to respond. Evaluate the two primary policy options available to the central bank: (1) maintaining the current policy stance to support output and employment, or (2) implementing a contractionary policy to combat the rising price level. In your evaluation, discuss the potential short-term and long-term consequences of each choice on inflation, output, and inflation expectations.

Evaluating Policy Responses to Supply-Side Inflation

An economy is experiencing a sharp increase in the general price level due to a sudden disruption in the supply of a key resource. A central bank decides to implement a policy to bring prices back down. Explain the primary trade-off the central bank faces in the short run as a result of this policy action.

The Economic Trade-Off of Combating Supply-Side Inflation

An economy experiences a sudden, significant increase in the cost of raw materials, leading to a rise in the general price level and a fall in aggregate output. If policymakers choose to implement a contractionary policy to combat the rising prices, what is the most likely short-term consequence for the economy?

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