For this section, assume the aftermath of the shock (analyzed in the previous section) has already happened. You are now describing the policy response (monetary of fiscal) and the effects of this policy - one policy at a time.

In response to a positive demand shock to follow its mandate, the Fed should (raise, decrease) the Federal Funds Rate (i.e., the nominal interest rate). Because inflation (does, does not) adjust right away in the short-run, this (raises, decreases) the real interest rate, R. In the IS-MP diagram, the (ISC, MPC) shifts (up, down, left or right) and the economy moves along the (ISC, MPC) to (increase, decrease) the output gap back to it's long-run equilibrium. The economy also moves along the (PC, OLC, 'neither PC nor OLC' or 'PC and OLC') to bring the ('change in inflation', 'cyclical unemployment', 'neither change in inflation nor cyclical unemployment' or 'change in inflation and cyclical unemployment') back to