When output is below potential and the policy rate has hit the floor of zero,the resulting fall in inflation leads to ________ real interest rates,which ________ output further,which causes inflation to fall further.
A)lower;increase
B)higher;depress
C)higher;increase
D)lower;depress

Question

Quizplus · Accepted Answer

When output is below potential and the policy rate is at zero, falling inflation leads to higher real interest rates (since real interest rate = nominal interest rate - inflation, and with falling inflation and a fixed nominal rate, the real interest rate increases). Higher real interest rates make borrowing more expensive, which depresses output further, leading to a further fall in inflation.

When Output Is Below Potential and the Policy Rate Has