Question

Suppose three economies are hit with the same temporary negative supply shock. In country A, inflation initially rises and output falls; then inflation rises more and output increases. In country B, inflation initially rises and output falls; then both inflation and output fall. In country C, inflation initially rises and output falls; then inflation falls and output eventually increases. What type of stabilization approach did each country take?

Short answer

For country A the stabilization approach will be to stabilize the output of the economy.

For country B, the stabilization approach will be to stabilize the inflation in the economy.

For country C, there is no need to choose any kind of monetary policy response.

Step-by-step solution

Step 1. Introduction for country A

The total amount of final goods and services provided into an economy's market in a given period of time is referred to as aggregate output.

Step 2. Explanation

Policymakers will choose to stabilise the economy's output as their stabilisation strategy. The monetary policy will be focused on the areas that are causing the output variations.

Step 3. Introduction for country B

Inflation is defined as a steady increase in the prices of goods and services within an economy over a set period of time.

Step 4. Explanation

The policymakers' stabilisation strategy will try to keep the economy's inflation under control. The focus of monetary policy will be on the factors that contribute to inflation rate swings.

Step 5. Explanation for country C

There is no requirement to choose a monetary policy response, and policymakers can maintain their independent monetary policy. The economy's self-correcting process has already begun to function, and the temporary negative supply shock will be lifted very soon without the need for any specific policy measures.