Question

economy is in the recessionary gap with higher inflation (thus there has been an AS shock), and what is happening is rather than stabilising the economy, the RBA is being "hawkish" and responding purely to their goal of targeting low inflation whilst ignoring employment/GDP. Thus, they implement higher interest rates in an attempt to lower interest, explain how they do that/why this shifts the AD curve left, and then how the economy moves to the new point in the economy,

Answer 1

Initially there is a recessionary gap due to aggregate supply shock. This implies the real GDP is less than its potential level and the rate of inflation is higher (or price level is high). At this stage the central bank has decided to raise interest rates to use monetary contraction and reduce money supply.

This is done by conducting open market sale of government bonds, raising the reserve requirement or raising the discount rate. This step would reduce bank reserves and so the lending capacity is undermined. This raises the rate of interest which reduces investment and consumption spending. Due to this reason, AD shifts left and economy experiences a decline in the real GDP as well as inflation rate.

Hence, the economy does experience a reduction in inflation rate but the economy is further stabilized.