Falling price levels reduce real GDP because
A) real exchange rates increase, reducing exports and increasing imports.
B) real income decreases and consumption spending decreases.
C) real interest rates increase, reducing investment spending.
D) real interest rates decrease, reducing investment spending.

Question

Quizplus · Accepted Answer

Falling price levels typically lead to an increase in real interest rates (the nominal interest rate minus inflation). When real interest rates increase, borrowing costs become higher. This discourages investment spending by businesses on capital goods, thereby reducing investment spending and, consequently, real GDP.

Falling Price Levels Reduce Real GDP Because