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Consider the closed-economy model. (a) Use IS-LM and AD-AS diagrams to show what happens to the...

Consider the closed-economy model.

(a) Use IS-LM and AD-AS diagrams to show what happens to the economy in the short-run, long-run, and during the transition, following an adverse supply shock . Explain in words what is happening.

(b) Suppose the central bank wishes to achieve output stability; that is, suppose the central bank would like to keep Y from ever changing. In response to the change in P from the adverse supply shock, what, if anything, can the central bank do to achieve this goal? How would the long-run equilibrium levels of Y , P and r in this case compare to the one where the central bank does nothing?

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