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(Please use the IS-LM concept to answer the question wherever applicable) 8. Can a central bank...

(Please use the IS-LM concept to answer the question wherever applicable)

8. Can a central bank with an inflation target fight cost-push inflation?

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Answer #1

8)

As we know in the case of the cost push inflation the price of goods and services increases. So, as the price increases implied the real money balance decreases, => the LM curve will keep shifting to the left side, => the interest rate keep increasing and the output of the economy as whole keep decreasing.

Here to reduce inflation the central bank can decrease money supply. So as the money supply decreases, => the AD decreases and shift left to AD2 given the AS, => the price will decrease and the equilibrium output also decreases, => the inflation will decreases.

So, here the maintain the targeted inflation the central bank can reduce the money supply in the case of cost push inflation but it is painful as the output of the economy also decreases.

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