FIGURE 15-12: Two Possible Responses to a Supply Shock When the dynamic aggregate demand curve is relatively flat, as in panel (a), a supply shock has a small effect on inflation but a large effect on output. When the dynamic aggregate demand curve is relatively steep, as in panel (b), the same supply shock has a large effect on inflation but a small effect on output. The slope of the dynamic aggregate demand curve is based in part on the parameters of monetary policy (θπ and θY), which describe how much interest rates respond to changes in inflation and output. When choosing these parameters, the central bank faces a tradeoff between the variability of inflation and the variability of output.