The financial market shock that occurred during the Great Recession increased the default-risk premium,and the housing shock that also occurred during the recession reduced wealth and residential construction.These two events would result in
A) a positive output gap and a rising inflation rate.
B) a negative output gap and a rising inflation rate.
C) a positive output gap and a falling inflation rate.
D) a negative output gap and a falling inflation rate.

Question

Quizplus · Accepted Answer

The increase in default-risk premium and the reduction of wealth and residential construction resulting from the financial market and housing shocks during the Great Recession would lead to a decrease in aggregate demand, causing a negative output gap. Additionally, the decrease in wealth would cause a decrease in consumption, which would result in a decrease in inflation rates. Thus, the correct choice is D, a negative output gap and a falling inflation rate.

The Financial Market Shock That Occurred During the Great Recession