When output is below potential and the policy rate has hit the floor of zero,if policymakers do nothing,output will ________ and inflation will ________.
A)rise;fall
B)fall;fall
C)fall;rise
D)rise;rise

Question

Quizplus · Accepted Answer

When output is below potential and the policy rate has hit the floor of zero, the economy is in a liquidity trap. In such a situation, the monetary policy becomes ineffective and traditional tools, such as lowering the interest rates, do not have any impact on the economy. If policymakers do nothing, the economy will remain in a slump, and output and inflation will fall. Therefore, the best choice is option B, which states that output will fall, and inflation will also fall.

When Output Is Below Potential and the Policy Rate Has