Applying the dynamic aggregate demand–aggregate supply framework we see that:

a. Stabilization policy is the use of monetary and fiscal policy tools to stabilize output and inflation.

i. Monetary policy can be used to shift the dynamic aggregate demand curve to offset changes in the quantity of aggregate output demanded. In practice, lack of information and lags in the impact of policy changes make this very difficult.

ii. Fiscal policy can shift the dynamic aggregate demand curve as well, but it is difficult to do in a timely and effective way.

iii. A positive supply shock that lowers production costs and shifts the short-run aggregate supply curve to the right creates an opportunity for policymakers to permanently lower inflation.

b. Better monetary policy is the most likely explanation for the increased stability of the U.S. economy from the mid-1980s until 2007.

c. An increase in potential output shifts both the short- and long-run aggregate supply curves to the right, driving output up and inflation down, resulting in expected inflation being above current inflation.

d. Globalization has the same impact as an increase in potential output. In the long run it raises output but inflation only changes if the central bank adjusts its target.

e. When confronted with a shift in the short-run aggregate supply curve, central bankers face a tradeoff between output and inflation volatility.