When the self-correcting mechanism of the ADI-IA model is particularly slow,the case for active fiscal policy is considerably strengthened when
A) the overnight target rate is at its effective upper bound.
B) the overnight target rate is at its effective lower bound.
C) government deficits are roughly equal to 50 percent of real GDP.
D) government spending exceeds government revenues.
E) recessionary or inflationary gaps are relatively small.

Question

Quizplus · Accepted Answer

When the self-correcting mechanism of the ADI-IA model is slow, it means that the economy is stuck in a recessionary or inflationary gap. In such a scenario, fiscal policy can be used to stimulate demand and speed up the adjustment process. This is particularly important when the overnight target rate is at its effective lower bound, which means that monetary policy has reached its limit and cannot be used to stimulate the economy further. Therefore, the correct answer is B.

When the Self-Correcting Mechanism of the ADI-IA Model Is Particularly