We saw that real shocks and AD shocks often occur simultaneously. When this happens, unless we know the exact size of each shock, we can’t be sure of the effect on both inflation and real growth: We’ll only know one or the other for sure.

In each case below, we can be sure that one of the four events will happen:

A fall in inflation A rise in inflation A fall in real growth A rise in real growth In the cases below, which changes can we confidently predict? (Hint: Draw an AD/Solow curve graph. Try several different combinations of the indicated shifts and see which outcomes are possible on the graph.)

a. The banking system becomes less efficient at building bridges between savers and borrowers, and investor confidence declines:

A negative real shock and a negative velocity shock occur simultaneously.

b. The banking system becomes less efficient at building bridges between savers and borrowers, and the Federal Reserve increases money growth: A negative real shock and a positive money shock occur simultaneously.

c. Biologists learn how to use computer simulations to rapidly search for molecules that would make promising medicines, and investors become optimistic about future profit opportunities: A positive real shock and a positive velocity shock occur simultaneously.