How might a real business cycle theorist explain the “Volcker recessio

How might a real business cycle theorist explain the “Volcker recession” of the early 1980s?

What will be an ideal response?

ANSWER

Volcker took office in October 1979 in the midst of high inflation and unemployment. Clearly, the long-run aggregate supply curve had shifted to the left. High and unpredictable inflation was undermining incentives to work and to invest. At first, Volcker’s appointment only added to the uncertainty: maybe inflation would now come down, maybe not. The decision to lower the federal funds rate in mid-1980 merely stimulated aggregate demand and did nothing to encourage output to recover, so inflation and unemployment remained high. It took more than another year for convincing anti-inflationary policy to allow economic distortions to abate and potential output to rise.