Outlook for Economic Activity and Prices and the Conduct of Monetary Policy  Chart 1  I.
The Basic Thinking on Monetary Policy  Mechanisms of Conventional Monetary Policy (1) Relationship between Interest Rates and Economic Activity Central banks  (2) Relationship between Economic Activity and Prices (Represented by the Phillips Curve) 3  Monetary tightening  Monetary easing  Interest rate hikes  Interest rate cuts  Firms and households  inflation rate, %  2 percent target  2  Increase in demand  Decrease in demand  Deterioration in the output gap  Improvement in the output gap  Improvement in the output gap  Deterioration in the output gap 1 -3  -2  -1  0  1  2 3 output gap, %  1  Chart 2  I.