In the early stages of a severe economic contraction there is often downward pressure of prices (deflation). Some economists believe that this deflationary pressure is stabilizing for theeconomy while others argue that the deflation leads to further destabilizing of the economy.

A. Using the AS-AD framework, illustrate and explain how deflation might be stabilizing if there were a shock to Aggregate Demand and help push the economy back toward full-

employment.

B. Paul Volcker successfully exploited this phenomenon, but with painful consequences. Explain the destabilizing effects of deflation and how the central bank might be anticipated to act in order to offset these effects.