In our analysis of Ch.10, we studied the aggregate demand (AD) and aggregate supply (AS) model in the context of recessions, expansions and supply shocks on economic activity. In addition, in Ch.12, we discussed the role of monetary policy on economic activity. As a result, the different type of "shocks" that affect economic activity bare consequences on the level of in?ation and output. Central banks, such as the RBA, can simultaneously pursue "stabilising prices" (i.e., maintaining a targeted level of in?ation) and "stabilising economic activity" (i.e., economic activity remaining at its potential level). However, not all shocks to the economy are equal. In response to this, economists/policymakers can either achieve price stability or economic stability. but not both. This trade-off ultimately poses a dilemma for central banks with dual mandates such as price stability and economic activity. On the other hand, New-Keynesian theory suggests that there is no trade-off between price stability and maintaining economic activity ? something called the "divine coincidence". Recall the long-run potential macroeconomic equilibrium condition:

Inflation LRAS Rate, T AS, AD, yP Aggregate Output, Y Fig. 1 - Macro-equilibrium price and output in the long-run. where the economy is at long-run macroeconomic equilibrium (point 1); output (or real GDP) is at its potential level at YP; and inflation (or the price level) is at its target rate (set by the central bank) at IT