When the policy rate hits its lower bound and inflation keeps falling,this portion of the aggregate demand curve is
A)downward sloping.
B)upward sloping.
C)flat.
D)undetermined.

Question

Quizplus · Accepted Answer

When the policy rate hits its lower bound, the central bank can no longer lower interest rates to stimulate demand, so the aggregate demand curve becomes upward sloping as lower interest rates no longer lead to higher consumption and investments. As inflation keeps falling, aggregate demand further decreases, leading to a shift to the left of the aggregate demand curve. This scenario is known as a liquidity trap.

When the Policy Rate Hits Its Lower Bound and Inflation