Changes in oil prices shift the short-run aggregate supply (SRAS) curve. Consider how volatility in oil prices may influence the economy’s short-run equilibrium, which occurs at the intersection of the dynamic aggregate demand (AD) curve and the SRAS curve.
(a) Suppose the monetary policy reaction curve is relatively steep. What does this imply about the slope of the AD curve? What does it imply about the variability of output and inflation? Explain.
(b) Suppose the monetary policy reaction curve is relatively flat. What does this imply about the slope of the AD curve? What does it imply about the variability of output and inflation? Explain.