Demand Shocks, Supply Shocks, and Monetary Policy Monetary policy can be effective in counteracting a demand shock. In panel A, the economy begins in full employment equilibrium at point e and then a demand shock reduces aggregate demand to AD₁, resulting in a new equilibrium (point a). Expansionary monetary policy will shift aggregate demand back to AD₀. This policy restores output back to full employment ($15 trillion), while restoring prices to their original level (100). Monetary policy is less effective in counteracting a supply shock. In panel B, a negative supply shock shifts short-run aggregate supply from SRAS₀ to SRAS₁. The new equilibrium (point a) is at a higher price level, 105, and lower output, $14 trillion, a doubly negative result. The Fed could use expansionary monetary policy to shift AD₀ to AD₁; this would restore the economy to full employment output of $15 trillion (point b), but at an even higher price level (110). Alternatively, the Fed could focus on price level stability, using contractionary monetary policy to shift aggregate demand to AD₂, but this would further deepen the recession by pushing output down to $13 trillion (point c).