You run the economy.
Steer inflation, growth, and unemployment using the two levers a government really has: monetary policy through interest rates, and fiscal policy through spending and taxes. Every quarter the model responds, and shocks arrive whether you are ready or not. This is the tradeoff every central bank actually faces.
How the model works
Output gap
Demand carries momentum and responds to the real interest rate against a neutral rate, plus fiscal impulse and shocks.
gap = ρ·gap − a·(realRate − r*) + fiscal + shock
Phillips curve
Inflation equals expected inflation plus a slope times the output gap, plus supply shocks. A hot economy pushes prices up.
π = πᵉ + κ·gap + supply
Okun's law
Unemployment moves opposite the output gap around a natural rate. Faster growth pulls people into work.
u = u* − β·gap
Expectations and the Taylor rule
Expectations adapt toward realized inflation, which is why inflation is sticky and costly to unwind. The Taylor rule readout is a benchmark for what a stabilizing central bank would set.
What the model shows
Five ideas explain almost everything this macroeconomics model does. None of them require a textbook, and all of them are the reason running an economy is harder than it looks from outside.
The output gap drives everything else
Nearly every number on this page is downstream of a single one: the output gap. It measures whether the economy is producing more or less than it comfortably can.
Picture an engine running above its rated speed. It works, and for a while it feels wonderful. Unemployment falls, wages climb, everyone is busy. But the strain has to go somewhere, and it comes out as inflation. Run the engine below its rated speed and you get the mirror image: idle capacity, people out of work, and prices going nowhere.
So when you move the interest rate, you are not really setting inflation directly. You are nudging aggregate demand, which moves the output gap, and inflation follows a quarter or two behind. That indirectness is what makes monetary policy so difficult to get right.
Why inflation gets stuck
Here is the nastiest part of the model, and of reality. Inflation depends heavily on what people expect inflation to be.
Once workers expect prices to rise 6% a year, they ask for 6% raises. Firms expecting the same write it into contracts and price lists. The expectation produces the outcome, and the outcome confirms the expectation. You can watch it happen here: let inflation sit above target for a couple of years and you will find it no longer falls just because you nudge the rate. You have to overcorrect, and overcorrecting costs jobs.
This is why central bankers sound obsessive about "anchoring expectations". An anchor that slips is brutally expensive to reset.
The tradeoff that broke the 1970s
The Phillips curve says you can buy lower unemployment with higher inflation, and the reverse. For a while economists treated it almost like a menu you could order from.
Then the 1970s arrived. Oil shocks in 1973 and 1979 drove production costs up across the entire economy, raising prices while simultaneously reducing output. Inflation and unemployment rose together, which the simple story said should not happen. The name for it was stagflation.
You can reproduce it. Advance until an oil price spike appears in the news feed, then try to fix it. Raising rates deepens the growth loss you have already taken. Cutting them feeds the inflation you already have. No setting fixes both, and that is the honest lesson rather than a flaw in the model.
What it costs to break an inflation
Set the policy rate to 11% and hold it for three years. Inflation collapses. Unemployment climbs toward 8%, growth stalls, and your approval rating falls apart.
The model is behaving correctly here. Something close to this happened in the United States in the early 1980s, when the Federal Reserve under Paul Volcker pushed rates toward 20% to break double digit inflation. The disinflation worked, and prices came back under control. It also produced the deepest recession since the 1930s to that point, with unemployment above 10%.
The simulator will happily let you do it. It will also let you feel why almost nobody wants to.
You are steering with a delay
Policy does not land on impact. Demand carries momentum and expectations move slowly, so a rate change you make today shows up across the following several quarters.
That means the numbers you are reacting to are already stale. It is like driving a car where the wheel responds four seconds after you turn it. The natural instinct is to keep turning, because nothing appears to be happening, and that is how you oversteer into the opposite ditch.
Things to try
Each of these is a real problem a policymaker has actually faced.
The soft landing
Cut the rate to 1% for two years to get the economy running hot. Now bring inflation back to 2% without letting unemployment pass 6%. This is the thing every central bank insists it can do.
Tame a shock
Advance until an oil price spike hits. From that quarter, get inflation under 3% within three years while keeping growth positive. Notice how much nastier a supply shock is than a demand one.
Fiscal only
Leave the rate untouched at 3% for the whole run and steer using only spending and taxes. It can be done, and it will show you why fiscal policy is such a clumsy stabilizer.
The debt trap
Run spending at +10 and taxes at 10% for a decade. Growth looks wonderful. Watch the debt to GDP tile, then try to unwind it without causing a recession.
Unfamiliar term? The course glossary defines the fifty this site actually uses, in the sense this site uses them.
Common questions about monetary and fiscal policy
Why does raising rates take so long to bring inflation down?
Two reasons built into the model. Demand carries momentum, so a rate change moves the output gap gradually rather than instantly. And expectations adapt slowly toward realized inflation, so once people expect high inflation it feeds into the next quarter regardless of policy. This is why central banks talk about acting early.
What is the output gap?
The difference between what the economy actually produces and what it could produce sustainably. A positive gap means the economy is running hot, which pushes inflation up and unemployment below its natural rate. A negative gap means idle capacity and rising unemployment.
What is the Taylor rule benchmark telling me?
It is a simple formula for what a stabilizing central bank would set the rate to, given current inflation and the output gap. It is a reference point rather than a command. Sitting far below it usually means you are stoking inflation, and far above it usually means you are choking growth.
Why can I not hit every target at once?
Because that is the actual problem. Cooling inflation means raising rates, which widens the output gap and raises unemployment. Cutting unemployment means stimulating demand, which pushes inflation up. The Phillips curve is exactly this tradeoff, and supply shocks make it worse by raising inflation and unemployment together.
About this model: a deliberately simplified aggregate demand and supply framework with a Phillips curve, Okun's law, adaptive expectations, and a Taylor rule benchmark. It is built for exploration and teaching, not forecasting. Real economies involve open-economy effects, financial channels, heterogeneous households, and expectations that are forward looking rather than purely adaptive. Parameters here are chosen to make the mechanisms visible on a human timescale.