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Chapter 24: Q. 23 (page 655)

Why does the self-correcting mechanism stop working when the policy rate hits the zero lower bound?

Short Answer

Expert verified

The self-correcting mechanism stop working when the policy rate hits the zero lower bound because A fall in short-run aggregate supply curve reasons a decrease inflation and it reviews a fall in the mixture output. This fall in combination output adds to bad output hole which causes even more poor output gap.

Step by step solution

01

Concept Introduction

The graphical presentation of all the goods and offerings which are demanded at one-of-a-kind rate levels inside the economic system is referred to as the combination demand curve.

02

Explanation

Policy rate is the hobby rate charged to the borrower as a ratio of the loan.The zero decrease sure policy prices causes the short-run aggregate supply curve to fall. This fall in mixture supply curve creates a poor output gap. A fall in short-run aggregate supply curve reasons a decrease inflation and it reviews a fall inside the mixture output. this autumn in combination output adds to bad output gap which causes even extra poor output hole.
for that reason, the self-correcting mechanisms forestall operating at zero lower sure policy fees.

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Most popular questions from this chapter

“If autonomous spending falls, the central bank should lower its inflation target in order to stabilize inflation.” Is this statement true, false, or uncertain? Explain your answer

. Why do activists believe that the economy’s selfcorrecting mechanism works slowly?

Suppose the current administration decides to decrease government expenditures as a means of cutting the existing government budget deficit.

  1. Using a graph of aggregate demand and supply, show the effects of such a decision on the economy in the short run. Describe the effects on inflation and output.
  2. What will be the effect on the real interest rate, the inflation rate, and the output level if the Federal Reserve decides to stabilize the inflation rate?

For aggregate demand shocks and permanent supply shocks, the price stability and economic activity stability objectives are consistent: Stabilizing inflation stabilizes economic activity, even in the short run. For temporary supply shocks, however, there is a trade-off between stabilizing inflation and stabilizing economic activity in the short run. In the long run, however, there is no conflict between stabilizing inflation and stabilizing economic activity.

Suppose three economies are hit with the same temporary negative supply shock. In country A, inflation initially rises and output falls; then inflation rises more and output increases. In country B, inflation initially rises and output falls; then both inflation and output fall. In country C, inflation initially rises and output falls; then inflation falls and output eventually increases. What type of stabilization approach did each country take?
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