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Chapter 24: Q. 7 (page 655)

In what way is a permanent negative supply shock worse than a temporary negative supply shock?

Short Answer

Expert verified

The temporary negative supply shock is worse than the permanent negative supply shock.

Step by step solution

01

Step 1. Introduction

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

02

Step 2. Explanation

Due to the constant negative supply shock, inflation and output in the economy tend to fluctuate, with the former increasing and the latter decreasing. Inflation will rise and output will fall as a result of the transitory negative supply shock. Because the long-term effect of a permanent negative supply shock on inflation and output is permanent, the economy returns to long-run equilibrium with the help of self-correcting mechanisms. As a result, both inflation and output return to where they were previously.

03

Step 3. Conclusion

Hence, the temporary negative supply shock is worse than the permanent negative supply shock.

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Most popular questions from this chapter

Because government policymakers do not consider inflation desirable, their policies cannot be the source of inflation.” Is this statement true, false, or uncertain? Explain your answer.

The Problems update with real-time data in MyLab Economics and are available for practice or instructor assignment. 1. On January 19, 2017, the Federal Reserve released its amended statement on longer-run goals and monetary policy strategy. It stated: “The Committee reaffirms its judgment that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve’s statutory mandate” and that “the median of FOMC participants’ estimates of the longer-run normal rate of unemployment was 4.8 percent.” Assume this statement implies that the natural rate of unemployment is believed to be 4.8%. Go to the St. Louis Federal Reserve FRED database, and find data on the personal consumption expenditure price index (PCECTPI), the unemployment rate (UNRATE), real GDP (GDPC1), and real potential gross domestic product (GDPPOT), an estimate of potential GDP. For the price index, adjust the units setting to “Percent Change From Year Ago.” Download the data into a spreadsheet.

  1. For the most recent four quarters of data available, calculate the average inflation gap using the 2% target referenced by the Fed. Calculate this value as the average of the inflation gaps over the four quarters.
  2. For the most recent four quarters of data available, calculate the average output gap using the GDP measure and the potential GDP estimate. Calculate the gap as the percentage deviation of output from the potential level of output. Calculate the average value over the most recent four quarters of data available.
  3. For the most recent 12 months of data available, calculate the average unemployment gap, using 5.6% as the presumed natural rate of unemployment. Based on your answers to parts (a) through (c), does the divine coincidence apply to the current economic situation? Why or why not? What does your answer imply about the sources of shocks that have impacted the current economy? Briefly explain.

In the United States, many observers have commented in recent years on the “political gridlock in Washington D.C.” and referred to Congress as a “Do Nothing Congress.” What type of policy lag is this describing?

Use a graph of aggregate demand and supply to demonstrate how lags in the policy process can result in undesirable fluctuations in output and inflation.

Assume that aggregate output is below the natural rate level. What would an activist policy recommend that the government do? Explain your answer.
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