Suppose we start with the US economy in a position of long run equilibrium, at potential output ! and inflation at the target level ". The Lehman Brothers bankruptcy in 2008 caused shockwaves through the entire financial system of United States disrupting financial markets and dampening business confidence.

a. Use a graph of the AD-AS model to explain the effect of the Lehman Brothers bankruptcy in the short-run on Real GDP, inflation and unemployment.

b. In the face of this shock how does divine coincidence simplify the job of policy makers?