What policy should a government implement to keep price level constant following a positive demand shock? i.e. keep the price level constant in the inflationary gap.

What policy should a government implement to keep the price level constant following a negative supply shock? In this case, there is a recessionary gap and the government wants to keep the price level at the same point it is at in the recessionary gap.

 

What policy should a government implement to keep price level constant following a positive demand shock? i.e. keep the price level constant in the inflationary gap.

Suggested fiscal policy measures:

• Reduce public spending
• Increase personal tax rates
• Increase indirect tax rates
• Withdraw subsidies to consumers
• Start charging more for public services and utilities

Suggested monetary policy measures:

• Increase lending interest rates
• Increase reserve requirement upon banks
• Increase liquidity requirement upon banks
• Sell government securities in market and suck the liquidity from consumers
• Rationalize the credit to highly inflationary sector
• Increase the margin requirements while discharging the loans
• Pursue moral persuasion targeting lower lending by banks